What is an Installment Loan? Understanding the Basics of Fixed Payment Borrowing

What is an installment loan? It’s a type of loan where you borrow a fixed amount of money upfront and repay it through scheduled, equal payments over a predetermined period of time, with interest. In plain English, it’s your classic “borrow money and repay it each month” type of loan. 

Borrow money, repay it with interest, done. These loans are nothing fancy, but they get the job done. If they were a food, they’d be rice – seemingly boring, surprisingly versatile, and incredibly popular. This guide will explore everything that you need to know about installment loans in easy, digestible language.

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What is an installment loan?

An installment loan is a form of debt where you borrow a lump sum of money and repay it in fixed monthly payments — installments being the key word here. These payments are typically made monthly and usually include both principal and interest. But, the exact repayment schedule depends on the loan. 

Installment loans are different from open-ended forms of debt (like credit cards or HELOCs) where you can continuously reuse the debt as you repay it.

How does an installment loan work?

Almost all installment loans boil down to three main steps:

1. Apply for your loan: Request a lump sum of money from a lender by submitting an application.

2. Agree to terms: During the application process, you and the lender will agree to terms such as the repayment timeline, interest rate, and other stipulations. 

3. Make regular payments: Once you’ve received your money, you’ll be on the hook to make small consistent payments until the loan is repaid. These payments include both principal (the amount you borrowed) and interest (a fee charged by the lender).

The terms of installment loans can vary widely depending on the type of loan. For example, mortgages tend to have lower interest rates and long repayment periods (usually 30 years)  while personal loans usually have higher interest rates and shorter repayment periods.

Types of installment loans

Any form of debt where you borrow money and then repay it in equal payments can be considered an installment loan. There are six common types of installment loans:

1. Personal loans
2. Student loans
3. Car loans
4. Mortgages 
5. Payday loans
6. Buy now, pay later loans

Let’s explore each of these loans in more detail.

Personal loans 

Personal loans are versatile financial tools that you can use for just about any legitimate purpose. Here are the fast facts: 

• Common loan size: $1,000 to $100,000
• Repayment terms: Usually between 1 to 7 years
• Average interest rate: 6% and 36% annually
• Common uses: Debt consolidation, home improvements, financing large purchases
• Unsecured: No collateral required

Learn More: Complete Guide to Personal Loans: Everything to Know

Student loans 

Student loans are used to help pay for higher education and associated costs like books, supplies, and living expenses. You can apply for student loans either through the government or private lenders. Here are the fast facts:

• Common loan size: $1,000 to $400,000
• Repayment terms: 5 to 20 years
• Average interest rate: 3% to 18% annually
• Common uses: Higher education and associated costs
• Unsecured: No collateral required

Learn more by reading our guide How to Apply for Student Loans Both From Federal and Private.

Car loans

Car loans are used to help finance the purchase of a vehicle. Here are the fast facts:

• Common loan size: $1,000 and $125,000
• Repayment terms: 1 to 7 years
• Average interest rate: 5% to 28% annually
• Common uses: Purchasing a vehicle
• Secured: The car acts as collateral for the loan. If payments aren’t met then the lender can repossess the car.

Learn More: What is the Best Place to Get a Car Loan?

Mortgages 

Mortgages are used to help purchase residential property. Here are the fast facts:

• Common loan size: $100,000 to $806,500
• Repayment terms: 15 to 30 years 
• Average interest rate: 3% to 8% annually
• Common uses: Buying a home
• Secured: The property acts as collateral for the loan. If payments aren’t met then the lender can repossess the house. 

Learn More: How to Buy a House: Ultimate Guide for First-Time Home Buyers

Payday loans

Payday loans are usually used to cover immediate expenses while waiting for your next paycheck. Here are the fast facts:

• Common loan size: $50 to $1,000
• Repayment terms: Typically by your next payday
• Average interest rate: 300% to 600% annually
• Common uses: Meeting everyday expenses
• Unsecured: There are no collateral requirements. However, the lender may ask for access to your bank account to repay the loan at the end of the term.

Due to their high interest rates, you should always take immediate action if you miss a payment on a payday loan. If you’re struggling to repay a payday loan then it might be worth exploring payday loan consolidation. 

Learn more by reading What Do You Need for a Payday Loan? 

Buy now, pay later loans

Buy now, pay later (BNPL) loans are used to help finance larger retail purchases. These loans are usually offered during the shopping checkout process and allow you to break up purchases into smaller installments that you pay over time. Here are the fast facts about BNPL loans:

• Common loan size: $50 to $20,000
• Repayment terms: Typically 4 payments, either bi-weekly or monthly 
• Average interest rate: 0% if paid on time. Otherwise, up to 36%
• Common uses: Financing larger retail purchases like furniture, electronics, or clothes
• Unsecured: No collateral required 

Secured vs. unsecured installment loan

Secured installment loans require collateral (something of value) as a condition for the loan. Lenders require collateral so that they have something to claim if the borrower falls behind on payments. For example, with a mortgage, the property itself is the collateral. If the homeowner stops paying their mortgage payments then the bank can reclaim the property.

An unsecured installment loan does not require collateral. Instead, the lender relies on the borrower’s creditworthiness to approve the loan.

How do installment loans affect your credit?

Taking out an installment loan gives you an opportunity to build your credit. If you repay the loan according to the pre-determined terms (or earlier) then you can boost your credit score. But, falling behind on payments could hurt your score.

Having multiple installment loans could also hurt your ability to get a new loan. Lenders might be less reluctant to lend you more money if they know that you already have multiple loans. 

Should you get an installment loan?

Installment loans are a good solution if you need a lump sum of money and have space in your budget to accommodate the loan’s payments.

Pros	Cons
Simple repayment: Installment loans have fixed monthly payments, making it easier to fit in your budget.	Potentially high interest rates: Some unsecured installment loans can have high interest rates, especially for borrowers with lower credit scores.
Flexibility (before borrowing): Installment loans come in many forms (mortgages, auto loans, personal loans), giving borrowers flexibility based on their needs.	Inflexibility (after borrowing): Once a loan is approved, the borrower is locked into a repayment plan and it can be difficult to change the terms.
Quick cash: Borrowers receive the full loan amount upfront, which is useful for paying large expenses like home improvements or medical bills.	One-time payments: Installment loans are a one-time deal. If you need more money then you’ll have to reapply for an entirely new loan.

How to get an installment loan

By this point, you’ve already scrolled pretty far down the page and probably know whether or not installment loans are right for you. Here’s how you can get an installment loan:

▶️ Check your credit score and report: Knowing your credit score will help you understand what type of loan you can get approved for and the interest rate you’ll likely pay.

▶️ Research and compare lenders: Be sure to shop around. Some lenders will likely offer better deals than others (lower interest rates, more flexible repayment terms, etc.)

▶️ Gather required documentation: You’ll have to provide legal documentation with your application and, when in doubt, it’s best to overprepare. We recommend providing proof of identity, income, employment, residence, and credit history.

▶️ Get prequalified or preapproved: This is when a lender provides an estimate of how much you might be able to borrow based on your basic financial information. It can help you get a rough idea of what your loan terms will look like prior to applying.

▶️ Choose your lender and apply: Revisit the lenders that offered you the best deals, cross your fingers, and apply! Just like with college applications, it’s a good idea to have a fallback or two lined up in case your first application gets denied. 

Are Installment Loans Right for You?

Installment loans are a great way to get a lump sum of cash with clear, predictable repayment terms. In total, there are six common types of installment loans:

1. Personal loans
2. Student loans
3. Car loans
4. Mortgages
5. Payday loans
6. Buy now, pay later loans

If an installment loan is right for you then determine the type of loan that fits your needs (based on the list above) and consider following the steps in the preview section.

We hope that you’ve found this article valuable – thanks so much for reading!

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