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How installment loans work in 2023

A common loan with lower interest rates

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Installment loans let consumers repay the funds they borrow over time, usually with a fixed monthly payment. These loans also come with a set repayment schedule, so borrowers know the exact date their loan will be paid off.

An installment loan is a closed-ended credit account that works for people who need cash for a large purchase or expense, such as a wedding or a home remodeling project.  Consumers also use installment loans for debt consolidation, since they let them escape the high interest rates credit cards charge and repay their debts with a predictable schedule.

Other types of installment loans include mortgages and auto loans. At the end of the day, the term "installment loan" can be used to describe most loans you repay over time with regularly scheduled payments.


Key insights 

  • The main difference between installment loans and other types of funding is that they come with regular payments and a set repayment schedule.
  • Installment loans are closed-ended credit accounts, which means you pay back the money you borrow over a set repayment period.
  • While installment loans can be a valuable financial tool, experts caution against accepting a high rate.

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 2022 was 16.27%. In contrast, the average rate on a 24-month personal loan that month was 10.16%. On a 60-month auto loan, the average rate was 5.50%.

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.

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, along with an explanation of what they're meant for.

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 and a set monthly payment that will not change.
Mortgages are another type of secured installment loan, using the home you own as collateral. If you fail to keep up with mortgage payments, you put your home at risk of foreclosure.
A home equity loan is another type of installment loan since these loans have fixed rates and set repayment terms. Often called a second mortgage, home equity loans let consumers access their home equity while using their home as collateral.
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, a set monthly payment and a fixed repayment schedule you agree to upfront.
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 and pay later, often with no interest if the amount is repaid over a specific period of time. This practice is becoming increasingly common among online retailers, with the help of third-party apps.
Student loans are another type of installment loan that can come with fixed interest rates or variable rates. Federal student loans have fixed rates; private student loans come with rates that are fixed or variable.

Pros and cons of installment loans

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

Installment loan prosInstallment loan cons
Often have lower rates than credit cardsOrigination and other fees
With fixed rate, there are fixed monthly paymentsRates high for those with bad credit
Frequently unsecuredRisk of damaging credit if you fail to repay
Can help you build creditNot ideal if you need continuous cash flow

How to get an installment loan

You should only apply for an installment loan if you have a specific purpose in mind. 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 to take out a personal loan, you should have a reason to borrow money. You might need it for debt consolidation or a large purchase you want to make. If you can’t justify taking out the installment loan, pause and reflect on why you want it.

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

Once you've decided why you want the loan, you should take steps to compare your loan options. You may be able to check your rate and gauge your approval odds with an online lender before you apply. However, this depends on the installment loan you're applying for. You can also compare loan options with lenders in your local area. You can check with your bank if you have an existing relationship with them or a local mortgage broker.

Either way, you should strive to compare rates and terms across at least three different lenders offering the amount you need to borrow. 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," Weitz, from United Capital Source, says.

Once you're ready to apply, you can usually do so online and from the comfort of your own home. You will need to share personal information in your loan application. This includes your full name, address, phone number, employment information, annual salary, Social Security number and other details.

FAQ

Is an installment loan a good idea?

Taking out an installment loan is a common option for making a significant purchase, dealing with a financial emergency or consolidating debt. Just make sure you compare rates from different lenders and can afford the monthly payment in your budget.

How long do you have to pay off an installment loan?

The repayment schedule for installment loans varies. For example, it's common to make monthly payments on a mortgage for up to 30 years, whereas personal loans typically have much shorter repayment timelines.

What credit score do you need for an installment loan?

The credit score needed for an installment loan varies based on the loan type and the lender. As a general rule, people with all types of credit profiles can find installment loans — but those with lower credit scores have to pay higher rates.

Can I get an installment loan with bad credit?

You may be able to get an installment loan with bad credit, but you'll almost certainly pay a higher interest rate and fees. You can save money over the long run if you improve your credit score before you apply for an installment loan.

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    Bottom line

    Installment loans come in all different forms, but they tend to share similar basic characteristics, including a set repayment schedule with regular monthly payments. You can get an installment loan to purchase a home or car, fund a home renovation, pay or consolidate bills, or for just about any other purpose.

    If you're in the market for an installment loan, you should know that many of the best loan options are offered online and that you'll position yourself for the best deal if you take the time to shop around. Make sure you read over the fine print of any loan agreement you're considering and only move forward once you have done your research.

    ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. To learn more about the content on our site, visit our FAQ page. Specific sources for this article include:
    1. Federal Reserve, "Consumer Credit - G.19." Accessed Nov. 28, 2022
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