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An unsecured loan doesn’t require collateral. Learn about how this kind of loan works, the types and what to consider before getting one.
Sara Coleman
Chances are you’ll need to take out an installment loan at some point during your adulthood. An installment loan lets you borrow a lump sum and repay your lender through a series of regular repayments. Mortgages, auto loans, student loans and personal loans are all types of installment loans.
Most installment loans require monthly payments. However, some installment loans have different payment frequencies. For example, you may be required to make payments weekly, biweekly or even quarterly.
With an installment loan, you borrow a specific amount of money, receive it all at once and pay it back in regular payments, or installments, over the loan’s repayment term.
Most installment loans have a fixed principal and interest (P&I) payment structure, while others have a principal plus interest (P+I) payment structure.
With this structure, your regular payment amount never changes, but the amount of that payment applied to principal and interest varies. The P&I payment is determined using an amortization schedule that calculates how much principal you must pay each period to repay the loan in full.
For example, let’s say you borrow $2,400 with an interest rate of 6% and a six-month repayment term. As shown below, your monthly payment of $407.03 won’t change. However, because it’s a P&I payment, the principal portion of the payment will increase and the interest portion will decrease over time.
Beginning loan balance | Total payment | Principal portion | Interest portion | Ending loan balance | |
---|---|---|---|---|---|
1st payment | $2,400.00 | $407.03 | $395.03 | $12.00 | $2,004.97 |
2nd payment | $2,004.97 | $407.03 | $397.00 | $10.02 | $1,607.97 |
3rd payment | $1,607.97 | $407.03 | $398.99 | $8.04 | $1,208.98 |
4th payment | $1,208.98 | $407.03 | $400.98 | $6.04 | $807.99 |
5th payment | $807.99 | $407.03 | $402.99 | $4.04 | $405.00 |
6th payment | $405.00 | $407.03 | $405.00 | $2.03 | $0.00 |
While P&I payments are the most common structure, some installment loans use a principal plus interest (P+I) payment structure instead. With P+I payments, the amount of principal you pay each period never changes and is evenly divided over the loan’s term. However, the total payment will change as the interest owed for each period varies.
In the same example as before, the P+I payment breakdown over the life of the installment loan is shown below. The principal portion of the payment never changes, but the amount of interest and total payment change each payment period.
Beginning loan balance | Total payment | Principal portion | Interest portion | Ending loan balance | |
---|---|---|---|---|---|
1st payment | $2,400.00 | $412.00 | $400.00 | $12.00 | $2,000.00 |
2nd payment | $2,000.00 | $410.00 | $400.00 | $10.00 | $1,600.00 |
3rd payment | $1,600.00 | $408.00 | $400.00 | $8.00 | $1,200.00 |
4th payment | $1,200.00 | $406.00 | $400.00 | $6.00 | $800.00 |
5th payment | $800.00 | $404.00 | $400.00 | $4.00 | $400.00 |
6th payment | $400.00 | $402.00 | $400.00 | $2.00 | $0.00 |
While the interest rate was fixed in our P+I example, lenders often use P+I payments for loans with variable interest rates. The reason is that this type of payment structure is designed to allow for the interest charges to change each payment period, something that often occurs with a variable rate.
» MORE: Interest rates and how they work
To get an installment loan, you'll fill out an application with a lender or a marketplace that offers access to multiple lenders. The application will require basic information about your identity, income and credit status. You can get installment loans from banks, credit unions and even online lenders.
Before officially applying, here are some factors to consider when looking for an installment loan:
As you’re shopping for an installment loan, take time to research the available options. Lakhbir Lamba, head of consumer lending at PNC Bank, said you should make sure to “evaluate the interest rate, repayment term, fixed monthly payment and any fees. Compare these from multiple credible lenders and don’t forget to read the fine print."
Reading the fine print is an important step, as this is where you may find differences between installment loans. For example, if your goal is to pay the loan off faster than scheduled, ensure the loan doesn’t include a prepayment penalty.
Many of the loans you’re already familiar with — mortgages, personal loans, auto loans, etc. — are common installment loans. These loan types wouldn’t be realistic for many borrowers without the option to repay in installments.
Auto loans are secured by the vehicle you’re financing. This means the lender has a lien on the vehicle title until you pay off the loan. When you fully repay the loan, the lender will provide you with a lien release showing it no longer has rights to your vehicle.
Due to the unsecured nature of most personal loans, they tend to have higher interest rates than other types of installment loans. Personal loan terms tend to last from one to five years, but this will vary by lender.
Qualifying for a mortgage is a much more extensive process than qualifying for a car loan or a personal loan. You’ll need to submit documentation to your lender, and the lender will need to order an appraisal, plus about a dozen other potential steps depending on the type of mortgage you’re taking out. Closing on a mortgage usually takes 30 to 60 days.
» MORE: 15-year vs. 30-year mortgage
You can also choose to apply for a private student loan through a bank, credit union or other lender. Private student loans typically have higher interest rates than federal student loans, and you’ll probably need to demonstrate good credit or find someone to co-sign with you who has good credit.
Student loan borrowers pay back their loans over time. Ten years is a standard term for both federal and private student loans, although a consolidated loan may have a term between 10 and 30 years.
With a federal student loan, payments aren’t due until after you graduate, leave school or change enrollment status; some private student loans require installment payments to start while you’re in school. Also, some federal loans include subsidies to cover interest while you’re enrolled.
Depending on the type of PAL, you can borrow up to $1,000 or $2,000, and you can repay the funds in installments from one to six or 12 months. The maximum interest rate you’ll pay on a PAL is capped at 28%, making this a much more affordable option than a payday loan.
Many BNPL loans don’t require you to pay interest if you pay in full during the loan’s term. If you don’t fully repay the loan on time, you might be charged fees or deferred interest for the entire loan period. Carefully read your agreement to understand the potential costs and fees.
While many BNPL lenders don’t use a hard credit check to approve your installment loan or report payments to the credit bureaus, others do. So, it’s essential to pay attention to what’s required so you understand the terms of the loan and its potential credit score impact.
Installment loans have a lot of upsides, especially for those with higher credit scores. But they can easily be mismanaged.
Since installment loan types and terms vary widely, “consumers should also consider their financial goals, credit history and overall financial health to ensure they choose a financing option that aligns with their unique circumstances and contributes positively to their long-term financial well-being,” recommended John Owens, executive vice president of Monterey Financial Services in Oceanside, California.
... consumers should also consider their financial goals, credit history and overall financial health to ensure they choose a financing option that aligns with their unique circumstances …”
While installment loans make budgeting easy since you repay a consistent amount each period, they’re not always the right option. For instance, if you want the option to make a lower payment or anticipate needing to borrow repeatedly, you might consider a line of credit or credit card.
Gates Little, president and CEO of The Southern Bank in Alabama, says a downside of an installment loan is that there’s no option to make a lower minimum payment; rather, your payment never changes. Little explained that if you lose your income, “that regular monthly payment can feel less affordable and may be harder to make.”
So, before you get an installment loan, always make sure you can afford the payment. If you want payment flexibility, credit cards or lines of credit often only require a minimum payment, but they may carry higher interest rates.
Credit cards are preferable to installment loans if you’d like to repeatedly borrow money and plan to repay the money very quickly (e.g., within a month).
If you can’t repay the borrowed money quickly, you’ll likely pay less interest with an installment loan, as installment loans often have much lower interest rates than credit cards.
Budgeting for installment loans is also easier since their payments and interest rates are usually fixed. Credit card interest rates are usually variable, so your interest costs increase in a rising interest rate environment.
A line of credit is similar to a credit card in that you can borrow money and repay it over and over again. This type of financing works well when you want to be able to access funds more than once.
If you have a lot of equity in your home, you might consider getting a home equity line of credit (HELOC). With this type of line of credit, your home is offered as collateral, so you can typically get better rates with a HELOC than with an unsecured line of credit. Plus, you might be able to borrow more money.
Many HELOCs have two distinct periods. During the draw period, you can borrow and repay the money as often as you want. During the repayment period, you can no longer borrow money. A draw period typically lasts 10 years, and the repayment period might be an additional 10 to 20 years.
Yes, installment loans can affect your credit score. Most lenders will do a hard credit check before issuing you final approval for an installment loan, and they will report your payments to the credit bureaus. If you make on-time payments, your credit score might increase, whereas late payments will have the opposite effect.
Yes, some lenders specialize in installment loans for those with bad credit. Your credit score, however, is a big factor in determining your interest rate, so bad-credit installment loans usually have high rates.
If you have a high-interest installment loan, check if your lender imposes a prepayment penalty. If not, you can pay off the loan early to save on interest. If you have a loan with a prepayment penalty, it may not make financial sense to pay off the loan early.
No, a credit card is a form of revolving credit, not an installment loan. With revolving credit, you aren’t borrowing a lump sum and paying it back in installments; instead, you can repeatedly borrow money up to a limit and pay back the money monthly, either partially or in full.
If you don’t pay the full credit card balance at the end of the monthly billing cycle, you are carrying over, or “revolving,” the balance to the next month (and paying interest on your balance).
Taking out an installment loan is a common way to borrow money to cover a big expense. You get a lump sum of cash and pay it back in regular installments. Many installment loans have fixed interest rates with equal monthly payments, which makes budgeting and planning easy.
If you’re considering an installment loan, compare offers from various lenders, including your local bank or credit union and online companies, to find the loan with the lowest cost that you’ll qualify for. Ensure you understand all the loan terms, like the APR, the monthly payment, the number of payments, the late fee amount and whether there is a prepayment penalty.
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