What is an installment loan?
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- An installment loan is a lump sum of borrowed money that is repaid through monthly payments over a fixed period of time.
- Mortgages, auto loans, personal loans, and student loans are a few common examples of installment loans.
- When shopping for an installment loan, pay close attention to the interest rate, repayment terms and any additional fees.
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When consumers need to borrow money, they have two main options — revolving credit or an installment loan. Each type of lending product has its own set of pros and cons.
Revolving credit lines, like credit cards, can be a good way to pay for smaller loan amounts that you plan to repay in a short period of time. But if you want to borrow a large amount of money and would like to repay it over a longer period, an installment loan will be a better fit.
Here's what you need to know about installment loans.
Installment loan definition
An installment loan is a specific amount of borrowed money that is paid back through monthly payments over time. Interest rates can be fixed of variable, and interest is included in the monthly payments. The amount of time it takes to pay off the loan completely (the term) can range from a few months to 30 years.
Installment loans can be either secured (requiring you to put up collateral such as your home or automobile) or unsecured (which you can get based solely on your creditworthiness.)
Several of the loans that consumers are most familiar with are installment loans. Here are a few examples:
Point-of-sale financing offers and "no credit check" emergency loans are often set up as installment loans as well.
How to get an installment loan
You can apply for an installment loan with just about any bank or credit union. You can also look at online personal loan lenders like Lightstream, SoFi, Avant, or others.
In some cases, you may be able to take out an installment loan directly from the company that you're buying a product from, like your auto dealership or furniture financing from your local furniture store.
Finally, borrowers can take out short-term emergency installment loans. Payday lending stores are some of the most notorious places for borrowers to get emergency cash. Payday loans can be incredibly expensive, often charging interest rates of 400% or more.
If you need emergency cash, consider applying for a Payday Alternative Loan (PAL) with your local credit union first. PALs cap interest rates at 28% and never charge more than $20 in fees.
Related: The best loans for fair credit »
What to look for in an installment loan
The first thing you'll want to look at with an installment loan is the interest rate you're being offered. Be sure to check whether the rate is fixed or variable. You may be able to get a lower initial rate with a variable-rate loan, but that rate could also go up over time.
If you plan to pay back your loan quickly, a variable-rate installment loan could save you money. But if you'll be in repayment for several years, locking in your interest rate with a fixed-rate loan may be the best way to go.
Next, check to see what origination fees (if any) the lender charges. Oftentimes, origination fees are a set percentage of the loan amount. But short-term loans may charge a flat fee instead. Shop around to try to find lenders that charge reasonable fees, or preferably none at all.
Finally, you'll want to consider the term length. In general, the longer the term, the more interest you'll pay. But a longer term will also typically mean lower payments. If you're looking to save the most money overall, try picking a shorter term. But if monthly cash flow is your top priority, a longer term could make sense.
How to save money on an installment loan
The interest rate that you're offered on an installment loan will be based, in part, on your credit score. So improving your credit score before you apply is one of the best ways to save money on an installment loan.
How can you improve your credit score? Making on-time payment on all your credit accounts is a great start. And lowering your credit utilization rate could give your score a quick boost as well. Also, periodically check your credit report for mistakes. If you find any, be sure to fix them before you apply for an installment loan.
Another potential way to qualify for better rates on installment loans is to improve your debt-to-income ratio. For example, paying down your credit cards or paying off your auto loan before you apply for a mortgage could make a difference in what rate you're offered.
Finally, one of the simplest ways to save money on an installment loan is to just pay it off faster. While installment loans have fixed monthly payments, most lenders will allow you to pay extra whenever you'd like. By paying your loan off earlier than agreed, you could cut out several months or years of loan interest.
Is an installment loan right for you?
If you like the idea of being able to know exactly when your loan will be paid off, an installment loan could be a great fit. And since they typically come with predictable monthly payments, installment loans can be easier to budget for.
However, flexibility is one area where installment loans fall short. Once the funds have been disbursed, you can't borrow any more from an installment loan. So if you're not sure exactly how much money you'll need, a revolving line of credit may be a better option.
Installment loan FAQs
What is an installment loan and how does it work?
An installment loan is money that you borrow in a lump sum and repay, with interest, in monthly payments over a fixed period of time. The amount of time that it takes to pay off the loan can range from a few months to 30 years.
What is an example of an installment loan?
Examples of installment loans include personal loans, auto loans, mortgages, and student loans.
What are the two types of installment loans?
Installment loans can be secured and unsecured. Secured loans, such as mortgages, require collateral that the lender can seize if you fail to repay. Personal loans are typically unsecured and issued based on your creditworthiness.