An installment loan is a type of loan that is repaid over time with a set number of scheduled payments. These payments are typically equal in amount and made at regular intervals, such as monthly or bi-weekly. The loan is typically secured or unsecured, and the interest rate and fees are fixed.
How does an installment loan work?
An installment loan works by borrowing a set amount of money and then repaying it over time with interest. The borrower will typically make regular payments, such as monthly or bi-weekly, until the loan is fully repaid. The interest rate and fees are typically fixed, and the loan can be secured or unsecured.
Advantages and Disadvantages of installment loans
- Ability to borrow a large sum of money
- Fixed interest rates
- Predictable monthly payments
- Typically have a lower interest rate than credit cards
- Potential for high interest rates
- Penalties for late payments
- Risk of falling behind on payments
- Hard credit check that can temporarily lower your credit score.
Types of installment loans
Auto loans are installment loans used to finance the purchase of a vehicle. They typically have a fixed interest rate and a fixed term, such as 36 or 60 months.
Mortgages are installment loans used to purchase a home. They typically have a longer term, such as 15 or 30 years, and a fixed interest rate.
Student loans are installment loans used to finance the cost of higher education. They typically have a fixed interest rate and a fixed term, such as 10 or 20 years.
Personal loans are unsecured installment loans that can be used for a variety of purposes, such as debt consolidation, home improvement, or unexpected expenses. They typically have a fixed interest rate and a fixed term.
Buy-Now, Pay-Later Loans
Buy-now, pay-later loans are installment loans offered by retailers to allow customers to purchase items and pay for them over time. They typically have a fixed interest rate and a fixed term.
How installment loans affect your credit
Applying for an installment loan often requires a hard credit check, which can temporarily lower your credit score a few points. However, installment loans can strengthen your credit if you make consistent, on-time payments. Reputable lenders report on-time payments to at least one of the three major credit bureaus, Equifax, Experian and TransUnion. Payment history makes up 35% of your FICO score, and on-time installment loan payments help build that history.
The consequences for missed or late payments can be severe. A payment that’s 30 days or more late can knock up to 100 points off your credit score. To avoid this, most lenders have the option to set up automatic payments, which removes the pressure of remembering to pay. It’s important to make payments on time and as agreed to maintain a good credit score.
Alternatives to installment loans
- Personal lines of credit: A personal line of credit is similar to a credit card in that it allows you to borrow up to a certain limit and pay back the borrowed amount over time. Personal lines of credit typically have a lower interest rate than credit cards, and can be a good option for those who need flexibility and access to funds as needed.
- Credit cards: Credit cards can be a good alternative to installment loans because they allow you to borrow money and make payments over time. However, credit cards typically have a higher interest rate than installment loans, and it can be easy to accumulate high levels of debt if not used responsibly.
- Home equity line of credit: A home equity line of credit (HELOC) is a type of loan that uses the equity in your home as collateral. It can be a good alternative to installment loans because it typically has a lower interest rate, and the interest may be tax-deductible. However, it also puts your home at risk if you are unable to make payments.
- Peer-to-peer lending: Peer-to-peer lending is a type of lending that connects borrowers and investors directly. It can be a good alternative to installment loans because it can offer lower interest rates and more flexible terms. However, peer-to-peer lending can be less regulated and has a higher risk of default.
What is the difference between a personal loan and an installment loan?
A personal loan is a type of installment loan that can be used for a variety of purposes. An installment loan is a loan that is repaid over time with a set number of scheduled payments.
Do installment loans require a credit check?
Yes, most installment loans will require a credit check. However, there are some lenders that offer loans without a credit check.
Can installment loans be paid off early?
Yes, most installment loans can be paid off early. However, some loans may have prepayment penalties, so it is important to check with the lender before making an early payment. Some lenders may also offer flexible payment options, allowing you to make extra payments or pay off the loan in full without penalty.