How Installment Loans Work in 2026

What is an installment loan?

When you take out an installment loan, you get whatever you’re purchasing or a lump sum of cash in exchange upfront. With an installment loan like a mortgage or an auto loan, for example, you’re buying a home or a car and agreeing to repay your loan with fixed monthly payments. With a personal loan, on the other hand, you'll typically receive a check or wire transfer to your bank account.

One major benefit of installment loans outside their set repayment schedule is that they offer lower rates than credit cards. The Federal Reserve reported the average annual percentage rate (APR) on credit cards in August 2025 was 21.39%. In contrast, the average rate on a 24-month personal loan that month was 11.14%. On a 60-month auto loan, the average rate was 7.64%.

Installment loans also have a set repayment schedule; most come with a fixed interest rate instead of a variable one. That makes installment loans different from credit cards, which almost always have a variable rate.

Installment loans vs. other loan types

When you want to borrow money, understanding your options helps you make the right choice for your situation. Installment loans work best when you need a specific amount for a one-time expense and want predictable payments. You’ll know exactly when your loan will be paid off.

Credit cards and lines of credit offer more flexibility since you can borrow repeatedly as you pay down your balance. However, revolving credit often carries higher interest rates and can be harder to pay off.

Payday loans might seem convenient, but their extremely high costs make them the most expensive option. A two-week payday loan typically costs $15 to $30 per $100 borrowed, which equals an annual percentage rate over 400%.

Here’s how installment loans compare to other common types of credit.

» MORE: Personal loan vs. credit card: Which is better?

Types of installment loans

Installment loans are secured or unsecured, depending on whether collateral is required. Here’s a rundown of the types of installment loans on the market today and typical rates.

Secured installment loans

Secured installment loans require collateral, which reduces the lender’s risk and often results in lower interest rates for borrowers. If you fail to make payments, the lender can seize the collateral to recover its money.

Auto loans

Auto loans are secured installment loans that use the vehicle as collateral. Borrowers can use auto loans to pay for a new or used vehicle. Most auto loans have a fixed interest rate, which generally falls between 4% and 10% for borrowers with good credit, and a set monthly payment that will not change, typically 36 to 72 months.

Mortgages

A mortgage is another type of secured installment loan that helps you purchase a house. Most mortgages last from 15 to 30 years, though some lenders offer 40-year mortgages to certain borrowers.

Rates typically range from 6% to 8%, depending on market conditions and your credit score. Since mortgages use your home as collateral, failing to keep up with payments puts you at risk of foreclosure.

Home equity loan

A home equity loan uses your home as collateral, letting you borrow against the equity you’ve built up. Often called second mortgages, these loans typically offer lower rates than unsecured options but put your home at risk if you can't repay.

Unsecured installment loans

Unsecured loans offer flexibility since you don’t risk losing property. However, defaulting still damages your credit score and may result in collection actions or lawsuits.

Unsecured installment loans don’t require collateral, but lenders offset the higher risk by charging higher interest rates and reviewing your credit more carefully. Your credit score and income play bigger roles in approval decisions.

Personal loans

Personal loans are flexible installment loans you can use for almost any purpose; many people use them for things like debt consolidation, home improvement or large purchases. Most personal loans are not secured by collateral, although secured personal loans that require collateral exist.

Either way, a personal loan comes with a fixed interest rate typically ranging from 6% to 36% depending on your creditworthiness. They require a monthly payment and a fixed repayment schedule you agree to upfront, which usually spans two to seven years.

Student loans

Student loans for education expenses are another type of installment loan that can come with fixed or variable interest rates. Federal student loans have fixed rates (6.39% to 8.94% in November 2025) and don’t typically require credit checks. Private student loans from financial institutions come with rates that are fixed or variable, often ranging from 4% to 14%, and require credit checks.

Point-of-sale financing (BNPL)

Some retailers offer merchandise with the option to pay off the cost over a set repayment period. An example is a home furniture store that lets you buy now, pay later (BNPL), often with 0% interest if the amount is repaid over a specific promotional period (typically three to 12 months). This practice is becoming increasingly common among online retailers, with the help of third-party apps.

Pros and cons of installment loans

Installment loans are typically a more predictable funding option because they offer lower interest rates and regular monthly payments, said Jared Weitz, CEO of United Capital Source, which helps small businesses obtain loans. “This makes it easier to plan your finances monthly because you know exactly how much you will pay back towards your loan,” he said.

However, installment loans that use your property as collateral come with the risk of losing your assets if you cannot make payments.

Amortization schedule and how repayments work

When you take out an installment loan, your lender creates an amortization schedule, which is a detailed payment plan showing exactly how much of each monthly payment goes toward the loan balance (principal) and how much covers interest charges.

How principal and interest work in your payments

Each monthly payment on an installment loan splits between two parts: principal and interest. Early in your loan term, most of each payment covers interest charges. As time goes on, more of your payment reduces the principal balance. This shift happens because interest is calculated on your remaining balance, which gets smaller with each payment.

Say you borrow $10,000 at 8% interest for three years. Your monthly payment is $313. Here’s how your payments break down:

Notice how the first payment applies only $247 to your loan balance while $66 goes to interest. By your final payment, nearly the entire $313 reduces your principal. Over the loan’s life, you’ll pay $1,268 in interest charges, making your total repayment $11,268.

This pattern explains why paying extra toward principal early in your loan saves you the most money. When you reduce principal ahead of schedule, you cut the interest charges on future payments.

How lenders calculate fixed monthly payments

Most lenders provide payment calculators on their websites, so you don’t need to do the math yourself. Just enter your loan amount, interest rate and term to see your payment instantly.

Lenders use a standard formula to calculate your monthly payment amount based on three factors: loan amount, interest rate and repayment term. The payment formula considers:

• Loan amount: Principal you're borrowing
• Interest rate: Converted to a monthly rate by dividing the annual rate by 12
• Number of payments: Loan term in months

Here’s an example: Say you want to borrow $15,000 at 10% annual interest for five years (60 months).

First, lenders convert the annual rate to a monthly rate by dividing your interest rate by 12. They then plug your numbers into a somewhat complex payment formula. With this monthly rate, your payment comes out to $318.71 per month.

Over 60 months, you’ll pay $19,122.60 total, meaning $4,122.60 goes to interest charges. If you shortened the term to three years (36 months), your monthly payment would jump to $484, but you’d pay only $2,424 in total interest, saving $1,698.

The key takeaway: Shorter loan terms mean higher monthly payments but lower total interest costs.

How to get an installment loan

Follow these steps to find the right installment loan and complete your application successfully.

1. Clarify your reason for borrowing

Only apply for an installment loan if you have a clear reason to borrow. For example, you’ll take out a mortgage to purchase a home or an auto loan for a new or used car. If you want a personal loan, you should have a specific reason, whether it’s debt consolidation, home improvements or a large purchase. If you can’t justify taking out the installment loan, pause and reflect on why you want it.

2. Compare offers from multiple lenders

Compare offers from at least three different lenders before taking out an installment loan.

Shop around and compare loan options from at least three different lenders. Check with online lenders, your bank (especially if you have an existing relationship), credit unions or local mortgage brokers depending on your loan type. Many online lenders let you check your rate and gauge your approval odds before you formally apply, which won’t hurt your credit score.

3. Review all loan terms carefully

Once you’ve found a few viable options, compare more than just interest rates. Be sure to look at all the terms of the agreement, which are often buried in the fine print.

“Check out the loan term length, the monthly payment amount, the interest rate and the total loan amount,” advised Weitz. Also review any fees, prepayment penalties and late payment charges before making your decision.

4. Gather required documents

Collect the documents you’ll need for your application:

• Government-issued photo ID
• Social Security number
• Proof of income (pay stubs, tax returns or bank statements)
• Employment information (employer name, position, length of employment)
• Proof of address (utility bill or lease agreement)
• Bank account information

5. Complete your application

Once you’re ready to apply, you can usually do so online and from the comfort of your own home. You’ll need to provide personal information including your full name, address, phone number, employment details, annual salary and Social Security number. The application typically takes 15 to 30 minutes to complete.

6. Review and sign your loan agreement

If approved, carefully review your loan agreement before signing. Verify the loan amount, interest rate, monthly payment, repayment term and any fees match what you expected. Once you sign, funds typically arrive within one to seven business days, depending on the lender and loan type.

» MORE: Best installment loans

Alternatives to installment loans

If an installment loan doesn’t fit your needs, several alternatives might work better depending on your situation and financial goals.

• Credit cards: Credit cards offer revolving credit you can use repeatedly up to your limit. They work well for smaller, ongoing expenses or when you need flexibility. Many cards offer 0% introductory APR periods lasting 12 to 21 months. However, regular APRs typically range from 18% to 29%, which is higher than most installment loans.
• Home equity lines of credit (HELOCs): HELOCs let you borrow against your home’s equity with a revolving credit line. You only pay interest on what you use, and rates typically range from 7% to 10%. HELOCs work well for ongoing projects, like home renovations. The downside is that you risk losing your home if you can’t repay.
• BNPL offers: Buy now, pay later offers from retailers let you split purchases into equal payments with no interest if paid within the promotional period. These work perfectly for planned purchases when you’re certain you can pay off the balance before interest kicks in. Miss the deadline, and you’ll owe interest retroactively on the entire original amount.
• Credit union loans: Loans from credit unions often feature lower rates and more flexible terms than traditional bank loans. Credit unions are not-for-profit organizations that return savings to members through better rates and lower fees.

How installment loans affect your credit

Installment loans can help or hurt your credit score depending on how you manage them.

• Payment history makes the biggest difference. Your payment history accounts for 35% of your credit score — the largest single factor. Making on-time payments strengthens your credit, while late or missed payments damage it. A single late payment can drop your score by 50 to 100 points and stay on your credit report for seven years.
• Credit mix improvements help your score. Having different types of credit like installment loans, credit cards and other accounts, shows lenders you can manage various payment structures. Adding an installment loan to a credit portfolio that only has credit cards can boost your score by 10 to 20 points, though this factor only accounts for 10% of your overall score.
• Hard inquiries cause temporary dips. When you apply for an installment loan, lenders check your credit with a hard inquiry that typically lowers your score by five to 10 points. This impact is temporary, and your score usually recovers within a few months of on-time payments. Multiple loan applications within a 14- to 45-day window count as a single inquiry, so shop around without fear of multiple hits.
• Your credit utilization stays separate. Unlike credit cards, installment loans don’t affect your credit utilization ratio (the amount of available credit you’re using). However, paying down your installment loan balance improves your overall debt-to-income ratio, which lenders consider during future applications.
• Defaults devastate your credit. Failing to repay an installment loan leads to default, typically after 90 to 120 days of missed payments. Defaults can drop your score by 100 to 200 points, remain on your credit report for seven years and make future borrowing extremely difficult and expensive.
• Build credit strategically by choosing an affordable loan amount, setting up automatic payments and paying more than the minimum when possible. Even one installment loan managed well demonstrates creditworthiness to future lenders.

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