Breaking down installment loans: your friendly guide to borrowing smart

Debt can be a valuable tool in managing your finances, but there are so many different kinds of loans it’s hard for anyone to keep them all straight. By learning about different types of loans, you can be confident you’re picking the right one for you, whether you’re buying or renovating a home, paying for higher education, or covering an emergency. Instead of reaching for a credit card, you might consider getting an installment loan to help you manage your finances.  

Here’s what to know about getting and repaying installment loans.

What is an installment loan?

An installment loan is a simple way to borrow money. You get a fixed amount of money upfront, then make equal payments—called installments—over time. Several kinds of loans work this way. So, for instance, a personal loan is one kind of installment loan.

If you’re taking out a personal loan, you might receive the money by check or electronically in your bank account. With other installment loans, like student loans or mortgages, the lender might pay the money to someone else for you.

You then make equal payments until the loan, including interest, is repaid.

Types of installment loans

Installment loans can be used to pay for all kinds of expenses, and lots of people have more than one installment loan at the same time. These are some of the most common types of installment loans:

• Personal loans. Personal loans are the most flexible installment loans. You could use a single loan for multiple expenses, and you don’t need to spend all the money at once. Personal loans typically have shorter payment periods, often between one and five years, although longer terms are also available.

• Home equity loans. Home equity loans have the flexibility of personal loans, but are secured by the equity in your home. (To estimate the amount of home equity you have, take the current value of your home, then subtract what you still owe on the mortgage.) If you’re a homeowner, you may be able to get a larger loan or pay a lower interest rate with a home equity loan compared to a personal loan. The interest on home equity loans may be deductible on your federal tax return if the funds are used for home improvement. 

We’re not tax professionals and although we can offer general information, we cannot offer tax advice. Please reach out to a tax professional to discuss your specific situation.

• Mortgages. One of the most common installment loans is a mortgage loan used to buy a home. These installment loans are usually for longer terms. The most common are 15-year and 30-year mortgages. Mortgage loans are almost always paid directly to the seller of the home, not to the borrower, so you can’t use the money for other expenses.

• Auto Loans. Like mortgage loans, auto loans are normally paid directly from your lender to the person or dealership you’re buying the car from. Most auto loans have terms of five years or less.

• Student loans. Installment loans are also used to pay for higher education. Unlike most other installment loans, student loans often have complicated repayment terms. For example, if your financial situation changes, you may be able to pause your payments or change your monthly payment amount. Sometimes you can even have loans forgiven by working for the government or some non-profit organizations.

How installment loans impact your credit 

When you apply for an installment loan, the lender checks your credit report. That’s called a  hard credit check, and it may lower your credit score by a few points or more.

If you’re approved, the new loan appears on your credit reports, which show the original loan amount, the amount you owe, and the amount of your monthly payment.

Making your installment loan payments on time could help you build a positive payment history, which could improve your credit standing over time. After a loan is paid off in good standing, the payment history remains on your credit report for 10 more years.

Another factor that influences your credit standing is the variety of credit accounts you have. Credit cards show up on your credit report as open-ended or revolving loans. That means you could borrow up to your credit limit multiple times (by repeatedly paying down your balance). Installment loans show up on your credit report as closed-ended loans, since after you repay the loan, the account is closed. Managing different kinds of loans could improve your credit standing and widen your access to new credit accounts. 

Advantages of installment loans

• Quick funding. If you need money fast, a personal loan could get you funds sooner than waiting for a new credit card. Once your application is approved, you could have your money in as few as 3 business days (funding times vary). 

• Flexible uses. You could use a personal loan for expenses like moving, major purchases, or medical bills. 

• Pay for large purchases over time. If you have emergency expenses like car or home repairs, you may not have time to save the money to cover them.

• Fixed monthly payments. Unlike with a credit card, your monthly payment amount won’t change over time, which could make budgeting easier.

• Predictable repayment term. If you make all your payments on time, your loan will be completely paid off on a fixed schedule. If you make extra payments, you could repay your loan faster and save money on interest over time.

• Build credit history. Your on-time payments could help you improve or maintain your financial profile, even after the loan is repaid.

We can’t make any guarantee about what will happen to your financial profile. Everyone’s situation differs. Your financial profile is based on a number of factors besides your bill-paying history and your current unpaid debt, including the number and type of loan accounts you have, and how long you’ve had your loan accounts open.

• Simple fees. Installment loans don’t typically charge annual fees or other tricky fees, like some credit cards do.

Drawbacks of installment loans

• Fixed loan amount. If you need to borrow more in the future, you’ll have to take out another loan.

• Potential fees. Make sure you understand all the fees you’ll be charged before you take out an installment loan.

• Not everyone qualifies for a low interest rate. Your interest rate depends on your income, assets, and credit history. You could save money on interest by not borrowing more than you need. You could also shop for lenders offering interest rate discounts.

How to get an installment loan

Get pre-qualified

Online lenders may let you see if you’re pre-qualified for a loan without hurting your credit standing. Look for the right combination of loan amount and interest rate for your needs.

What to expect when you apply

Once you apply, your lender looks at your credit report to verify the information you provided, like income, assets, and employment. You may be asked to provide recent bank statements or pay stubs.

Factors lenders look at

Your credit profile is just one factor lenders look at when deciding how much you can afford to borrow, and what interest rate you’re charged. Another important factor is whether you have enough income to afford the monthly payments. A borrower with high income and a lower credit score may be able to borrow more than someone with low income and perfect credit. Make sure you know what you need to do to maximize your odds for approval.

Funding time

If you’re approved, once your information is verified and you sign the loan documents, you could receive a personal loan in as few as 3 business days (funding times vary). Home equity loans may take longer.