What Is An Installment Loan And How Does It Work?

Many who ask what an installment loan is might be surprised to learn that they may have already used this common type of financing under a different name. No matter the loan you receive, it’s essential to weigh pros and cons before closing on the agreement. Follow along to learn more about the many types of installment loans and what to expect before you complete your transaction.

What Is An Installment Loan?

An installment loan is a type of financing that provides borrowers with a lump sum of money that they must repay with payments, also known as installments, over a fixed period of time. Whether they’re called personal loans, auto loans, mortgage loans or countless other names, if you received a loan with a lump sum payment that you must pay back through regular payments on a certain timeline, you have an installment loan.

How Do Installment Loans Work?

Once you complete the application and approval process for an installment loan, you will either receive a lump sum payment for the entire amount of your loan or the funds will be paid to the seller, dealer or creditor who’s providing the product you’re using the loan to buy.

Depending on your loan terms, you will have to make payments to the lender on a regular schedule until the loan is paid off. Your loan may include interest payments that will also be paid off with each installment.

Installment loans differ from revolving loans, such as credit cards. Instead of receiving a fixed lump sum payment that you must pay off over a fixed period of time, revolving loans allow you to continually borrow money up to a limit on an open-ended basis.

Common Types Of Installment Loans

Below are some of the most popular types of installment loans.

Personal Loans

A personal loan is a straightforward type of installment loan in which you borrow a lump sum of cash that you may need for a variety of reasons, such as expensive home improvements or convenient debt consolidation. Most personal loans are unsecured, meaning that you do not have to provide any collateral to receive the loan. While this means you don’t have to risk losing any of your valuable assets if you fail to repay the loan, it also makes the loan riskier for the lender. That will typically require them to loan a smaller amount with higher interest rates than a secured loan. 

Auto Loans

Auto loans are a type of installment loan that allows borrowers to use a lump sum to purchase a car, truck or other type of motor vehicle. Auto loans are secured by the vehicles themselves, so if you do not make the payments on your loan, the lender can repossess your car. While this arrangement makes the loans riskier for the borrower, it allows lenders to offer large enough loans to purchase expensive vehicles with reasonable interest rates.

Student Loans

Student loans are another common type of installment loan designed to help college students and their parents pay for the increasing costs of higher education. Both the federal government and private lenders offer student loans, but often with different loan terms. Federal loans offer less expensive financing, fixed rates and deferred payments until 6 months after the student graduates college. However, the limit that each student can receive from federal loans often doesn’t meet the total cost of college tuition. Private loans can make up the difference with unlimited loan amounts but are typically more expensive with stricter loan terms and repayment options.  

Mortgages

Mortgage loans provide borrowers with large lump sum payments to purchase their dream home and extended repayment timelines so the average buyer can afford to make regular payments over time. When you close on a mortgage loan, you receive the lump sum payment to pay for the house and typically agree to pay it back over 15 or 30 years. These payments can come with fixed or adjustable interest rates, meaning you may pay the same amount every month or a variable amount depending on the current economic conditions. The loans are secured by the homes, so if you don’t make your payments, the bank can foreclose on your home.

Pros And Cons Of Installment Loans

Make sure to research the benefits and drawbacks of installment loans before signing the dotted line.

Pros

Cons

Installment Loan FAQs

Below are some of the most common questions about installment loans.

Will an installment loan affect my credit score?

Yes, applying for installment loans usually requires a hard inquiry into your credit history, which will cause a temporary negative effect on your credit score. However, consistently making payments on time will improve your credit score in the long run.

What’s the difference between installment debt versus revolving debt?

Borrowers receive installment debt through a one-time lump sum payment of a fixed amount of money and pay it back through regularly scheduled installments. With revolving debt, instead of receiving a lump sum payment, borrowers get access to a line of credit up to a limit that they can borrow from at their own discretion and pay back at their own discretion as long as they meet specific repayment minimums described in their loan terms. For a specific example of the difference between the two types of loans, research the difference between a personal loan versus a personal line of credit.

How can I get an installment loan?

You can get an installment loan from various private lenders such as banks, credit unions, non-banking financial institutions or online lenders. You can also receive certain installment loans, such as federal student loans, from the federal government. If you’re looking to get a personal loan or another type of installment loan, make sure to shop around to several different lenders to ensure you get the best deal possible. 

The Bottom Line

An installment loan is a common type of financing that can provide much-needed funds to borrowers with a variety of needs. Installment loans are lump sum payments that are repaid on a regular schedule determined by the loan’s terms. With access to a potentially large amount of money and an extended time period to pay it back in affordable installments, you can pay for expensive purchases like a car or house or get your finances in order through debt consolidation. Depending on your financial goals, a personal loan can be a good option for you.  Apply for a personal loan today if it’s the right option for you!