What is installment credit?

Installment credit is a loan that comes with a fixed amount and repayment terms that are set up over time. The loan includes interest as well as any other applicable fees. Each repayment is an incremental amount of the total that you owe, which you will pay off over the course of a number of months or years. 

Examples of installment credit include auto loans, student loans, mortgages, and either business or personal loans. With installment credit, you know exactly how much you will need to pay each month, and you can even set up automatic monthly payments so you never miss a payment. 

How does installment credit work?

Installment credit or an installment account are other names for a loan with fixed repayment terms. In most types of installment credit, you will receive the full loan amount when the contract is signed. In most types of installment credit, the interest rate is set and built into the payment terms. 

In the case of mortgages, there may be variable interest rates. However, for most types of installment credit, you will have fixed monthly installment payments. In all types of installment credit, your installment balance is the amount remaining to be paid on the loan. 

Here is an installment credit example. If you receive a $20,000 auto loan with a fixed 5% interest rate and a 60-month repayment term, your fixed monthly payments will be $377. 

What types of credit are installment loans?

Installment loans are a part of daily life. Here are the most common types of installment loans.

Mortgages

Mortgages are a classic example of an installment loan used to purchase a house or property. Mortgages usually have repayment terms of 15 to 30 years. The property is used as the guarantee of the loan. 

There are both fixed interest rate and variable interest rate mortgages. In fixed interest rate mortgages, your monthly payment amount will be fixed for the duration of the mortgage. For variable interest rates, the exact repayment amount will change to reflect market norms of interest. 

Car loans

Auto loans are another example of the most common types of installment credit. With a car loan, you will receive the full amount of the loan when the contract is signed. 

Auto loans have fixed interest rates. Lower interest rates are available to borrowers with a higher credit score. Auto loan repayment terms are usually between 12 and 72 months. 

Personal loans

Personal loans are another type of installment credit. Personal loans can be obtained from banks or other lending institutions, as well as from private lenders. 

Personal loans are most often used for unexpected expenses like medical expenses or to consolidate debt. Interest rates for personal loans are usually higher. Repayment length for personal loans varies, from 12 to 96 months. 

Can installment loans improve my credit score?

Installment credit can improve your credit score if you make all monthly payments on time. Even one late payment can hurt your credit score. If used responsibly, installment loans can improve your credit score. 

Installment loans can also improve your credit mix, which makes up 10% of your credit score. If you also have another line of credit like a credit card, having a mix of lines of credit may further boost your credit score. 

What are the benefits of installment credit?

The benefits are of installment credit include:

• Predictable payments: Know exactly how much money you need to pay each month and plan your budget around that information. 
• Lower interest rates: Compared to revolving credit, installment credit usually offers lower interest rates. This leads to more savings in the long run.
• Plan for big purchases: With installment credit, you can plan for big purchases like a car, house, or college over time in a manageable way. 

Drawbacks of installment credit

The main drawback of installment credit are fewer opportunities for those with low or no credit scores. Loan terms are based on credit score. Borrowers with low credit scores can face high interest rates, additional fees, or penalties.

In addition, once the loan is offered, the terms are set. You cannot increase the installment credit amount. Borrowers who find they need additional funds will have to apply for a new line of credit or a new loan. 

Can you pay off an installment loan early?

Most installment credit will allow you to pay them off early. Be sure to check the terms as some types of installment credit have additional penalties if paid off early.

If you can pay off an installment loan early, you’ll save on interest and reduce monthly debt. Keep in mind your complete financial picture to avoid putting yourself in a financial bind to pay off a loan early. In many cases, it can be better for your total financial picture to continue with on time monthly payments for the duration of the loan. 

Installment credit vs revolving credit

Installment credit is a set loan amount with fixed monthly payments. The disadvantage is that you cannot take out additional funds. The advantage is you know the exact repayment amount and can budget around it.

In contrast, revolving credit changes each month based on expenses made. An example of credit revolving is a credit card. Revolving credit interest rates are much higher. 

For credit cards, average interest rates range from 18% to 23% APR or greater. With revolving credit, the borrower can choose to pay off the full amount each month or pay some amount while interest is accrued on the remainder. 

Summary of installment credit benefits

Installment credit loans are a part of daily life. Many people will use a mortgage to purchase their first home. 85% of all new cars in the U.S. are purchased with auto loans. Personal loans can be essential for families when faced with unexpected medical expenses or when looking to consolidate and pay off debt.
As long as you take the installment credit into your total financial picture, it can help with large purchases while adding to your credit file. If used responsibly—with on time monthly payments—installment credit is one more tool to build your credit score and credit history over time.

FAQ