What Is an Installment Loan and When Should You Use One?

An installment loan is when 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 home equity lines of credit (HELOCs) — where you can reuse the debt as you repay it.

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Key Takeaways

• An installment loan lets you borrow a lump sum and repay it in fixed monthly payments over a set term. Personal loans, mortgages, auto loans and student loans are all common examples.

• Repayment terms and interest rates vary widely depending on the loan type. Mortgages can stretch to 30 years with relatively low rates, while payday loans may be due by your next paycheck with annual percentage rates (APRs) of 300% or more.

• Secured installment loans require collateral, while unsecured loans rely on your creditworthiness. Secured loans are generally easier to qualify for but put your assets at risk if you default.

Summary generated by AI, verified by MoneyLion editors

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 make 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. Here are some examples:

• Mortgages tend to have lower interest rates and long repayment periods — usually 30 years.

• Personal loans usually have higher interest rates and shorter repayment periods — five to seven years.

Types of Installment Loans

Any loan 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:

Personal Loans 

Personal loans are versatile financial tools that you can use for just about any legitimate purpose.

• Common loan size: $1,000 to $100,000

• Repayment terms: Usually between 1 and 7 years

• Average interest rate: 6% and 36% annually

• Common uses: Debt consolidation, home improvements, financing large purchases

• Unsecured: No collateral required

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.

• 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.

• 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.

Mortgages 

Mortgages are used to help purchase residential property.

• 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.

• 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 (BNPL) Loans

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.

• 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 on time, 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 more 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.

How To Get an Installment Loan

You can follow these steps to get an installment loan:

1. 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.

2. 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.

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

4. 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.

5. 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. 

FAQs

Are payday loans installment or revolving?

Payday loans are typically considered installment loans as they are lump-sum loans with a strict repayment schedule.

Are installment loans legit​?

Yes, installment loans are legitimate financial products, but borrowers should choose reputable lenders to avoid predatory terms.

What is an installment loan example?

A car loan is an installment loan example because you make fixed monthly payments until it’s paid off.

What are the disadvantages of an installment loan?

They can have high interest rates, long-term financial commitments and potential fees for late payments.

What’s the difference between a personal loan and an installment loan?

A personal loan is a type of installment loan, but installment loans can also include mortgages, auto loans and student loans.

Do installment loans hurt your credit?

Installment loans can hurt your credit if you miss payments, but making on-time payments can improve your credit score.

Is it good to have an installment loan?

It can be beneficial if you need to finance a large expense and can manage the payments responsibly.

How many installment loans can you have?

There is no set limit, but having multiple installment loans can impact your debt-to-income ratio and borrowing ability.

Key Terms

• Principal: The original amount borrowed, not including interest or fees. Each monthly installment payment typically covers a portion of the principal plus accrued interest.

• Fixed monthly payment: A set payment amount that stays the same throughout the loan term. Fixed payments make it easier to budget since the amount due never changes.

• Secured loan: A loan backed by collateral such as a home or vehicle. If the borrower defaults, the lender can seize the asset to recover the outstanding balance.

• Unsecured loan: A loan that requires no collateral. Approval is based on the borrower's credit score, income and debt-to-income ratio, and interest rates are typically higher than secured loans.

• BNPL: A short-term financing option that splits retail purchases into smaller installments, often interest-free if paid on time. Interest rates can reach up to 36% if payments are missed.

Summary generated by AI, verified by MoneyLion editors

Sources

• Federal Student Aid. "Federal Student Loans."

• Consumer Financial Protection Bureau. 2024. "What are the costs and fees for a payday loan?"