What is an installment loan?

Key points

• An installment loan is a closed-ended form of debt: You borrow a lump sum and repay it in smaller amounts over time (with interest).
• Personal loans, student loans and mortgages are common examples of installment loans, which can be secured (by collateral) or unsecured (thanks to your creditworthiness).
• When you apply for, receive or repay an installment loan, there can be positive and negative impacts to your credit score and report.

An installment loan is a financial product that allows you to borrow money, which you repay over time. Those payments (or installments) are typically fixed, though the payment amounts could fluctuate (due to accruing interest or if you have a variable APR).

In other words, installment loans are likely what you think of when you hear the word “loan.” This category of debt can include things like personal loans, mortgages or student loans, among others.

How do installment loans work?

Before you can take out an installment loan, you have to qualify. That generally means having a solid credit score, especially for unsecured loans. Secured loans, by contrast, require you to put something up as collateral, like a house, car or cash. In exchange, you may not have to have stellar credit. But keep in mind that if you become unable to make money payments on a secured loan, you might lose that collateral.

Either way, you’ll have to fill out some sort of application to access installment loans, which the lender then reviews and approves or rejects. The timing will depend on the lender, but some options can offer funding within a day or two of accepting the loan terms.

Once you receive those installment loan funds, you begin to repay the loan. You’ll also pay interest and potentially fees (which vary depending on the loan type and lender), so you’ll end up repaying more than you originally borrowed.

“When you borrow the money, you’re going to have a defined repayment plan,” explains Brian Walsh, a Certified Financial Planner (CFP) and senior manager of financial planning at SoFi, a personal finance institution that offers loans. “So that way, after ‘X’ amount of years, you’re going to have that money paid back, assuming you make the payments when you’re supposed to.”

For example, let’s say you take out a $10,000 personal loan with an 11.99% fixed interest rate and a five-year term. You’d have to make monthly payments of about $222 per month until that term ends. But if there are discounts or extra fees—or if you miss or delay your monthly dues— that figure could change.

“As far as fees are concerned, it really depends on the type of loan and what lender you’re looking at,” he adds.

Tip: Some lenders will offer prequalification, which lets you see if you’re likely to qualify, and if so what your terms could look like. And it doesn’t impact your credit. So it’s an essential tool when shopping for installment loans.

Pros and cons of installment loans

These are the most important pros and cons of installment loans:

However, another vital factor to consider is how installment loans impact credit. And that’s a little complicated.

“Installment loans can help or hurt someone’s credit score, really depending on the overall situation,” says Walsh. That’s because installment loans impact credit in several ways:

1. When you apply, you’ll get a hard credit inquiry added to your credit profile. If you have too many of those, those can negatively impact your score.
2. Adding any new credit account to your profile will lower your average age of accounts, which can be a negative for your score.
3. If you’re using an installment loan to consolidate credit card debt, that’s going to lower your credit utilization and provide a greater mix of account types—both of which can boost your score.
4. Since you have a monthly payment, installment loans can impact your payment history. For example, if you miss a payment, that can decrease your score.

So in that way, installment loans can be a plus or a minus when it comes to credit. It all depends on how you use it.

Tip: According to Walsh, the CFP at SoFi, getting the best installment loan is about balancing the monthly payment with the interest rate to ensure that the benefits outweigh the negatives. For example, a longer term can lower the monthly payment, but it can also mean you’re paying more interest over time. “It’s trying to find the middle ground between keeping interest in check, but making the term long enough that it can easily fit into your budget,” he adds. To get a sense of how the math works, try out a loan payment calculator, like Calculator.net’s.

Examples of installment loans

Here are common financial products that are installment loans:

• Personal loans: These loans can be taken out for many reasons, including consolidating credit card debt, paying for big-ticket items or events (like a wedding), and covering unexpected expenses. Personal loans are usually unsecured.
• Student loans: These loans are specifically used to pay for higher education costs. They are available from both the federal government and private lenders. Federal student loans generally come with more robust borrower protections, and unlike private loans, the rates aren’t dependent on credit.
• Mortgages: These loans are used to purchase homes, and they use the house as a way to secure the debt. They’re usually repaid over 15 to 30 years.
• Auto loans: If you need to buy a car, these loans are designed for just that. Like mortgages, they use the purchased item to secure the debt. Repayment typically ranges from two to seven years.

Installment loan vs. line of credit: What are the differences?

At the end of the day, both of these options provide ways to borrow money. Both can also charge interest, typically require you to repay the money according to a monthly schedule, and have secured and unsecured options.

But there are also key differences. For example, while an installment loan lets you borrow a chunk of money at once, a personal line of credit has a draw period, during which you’d be able to take money out, up to the credit limit. Think of it as a form of revolving credit, like a credit card.

Also, unlike installment loans, lines of credit are more likely to have variable interest rates. But you’d only have to pay interest on your outstanding balance.