An installment loan allows individuals to borrow a predetermined amount in one lump sum. It also gives borrowers the ability to pay off the balance in equal monthly payments or installments.
Unlike credit cards or lines of credit, installment loans are closed-ended loan products. The borrower gets the entire balance in one go and if more funds are required, it is up to the individual to apply for another loan or negotiate with the lender.
The 5 Most Common Types of Installment Loans
Installment loans are one of the most common ways to finance a large purchase. While they all work in a similar way, the most common installment loans have different functions and interest rates.
While personal loans are the most common installment loans, auto loans, student loans, buy now, pay later loans and mortgages are also popular – and sometimes necessary – financing options.
1. Personal Loan
Personal loans can be used for essentially every legitimate expense and are offered by banks, credit unions and online lenders. The balance is paid in fixed monthly instalments, but some companies offer hardship payment relief or alternative repayment plans if an emergency arises and you are unable to make the payments.
There are lenders that offer personal loans for nearly every expense – from weddings to jewelry to vacation-related purchases – but not every lender or financial institution will offer loans for the same purposes. Some companies have restrictions on what the money can be used for, so make sure your needs are met before signing on the dotted line.
2. Auto Loan
Auto loans are specifically taken for the purchase of a car or related vehicle. While many dealerships offer in-house financing, credit unions, banks and online lenders also offer auto loans if you’re in the market for a lower rate, repayment flexibility or are looking to refinance.
Before you apply, do a financial audit and work out a repayment plan that works with your budget. An auto loan is a secured loan, which means that the loan is backed by your vehicle as collateral. If you default on your loan, the bank has the legal right to seize your vehicle to satisfy the outstanding loan.
3. Student Loan
Student loans are used to pay for a college education and related expenses such as books, supplies, housing, food, and tuition. Offered by both the federal government and online lenders, approximately 43 million borrowers currently hold student loans in the country.
Federal student loans are offered by the Department of Education through a streamlined application. Federal loans are available to every borrower attending a qualifying US college or university and all carry the same fixed interest rates. Because of the unique benefits and protections available to borrowers, it is best to turn to federal loans before looking at private loans.
Private student loans base your approval odds and interest rates on your creditworthiness and getting approved as a student can be difficult. Unlike federal student loans, private loans are distributed by many financial institutions and online lenders. Each company will have different qualifying requirements and interest rate ranges, so shop around to make sure you’re getting the best rate for your situation.
Mortgages are offered by many institutions, from national banks to credit unions to online lenders. There are five main types of mortgage loans, including fixed- and adjustable-rate options, large loans — also known as jumbo loans — government-insured mortgages, and conventional loans.
The mortgages come in 15- and 30-year options; The 15-year option will allow you to build equity and pay off the loan faster, while the 30-year mortgage gives your wallet breathing room in the short term by charging a lower monthly amount.
5. Buy now, pay later loan
Buy now, pay later (BNPL) apps break down the cost of purchases into installments so that people can afford more than they could afford without the loan. Most retailers – especially online retailers – now offer some sort of BNPL option.
With a positive repayment history, BNPL loans often do not charge interest or fees. Plus, they’re a convenient way to make purchases without racking up credit card debt and can be easier to get approved for than traditional personal loans.
There are different types of BNPL loan. Some companies require a hard credit check while others do not, and some companies may report your payment habits to the credit bureaus to help you build your credit score. However, a potential downside to these loans is that they may tempt borrowers to finance more than they can afford.
Pros and Cons of Installment Loans
Like every other type of financing option, installment loans have both advantages and disadvantages. Here’s what you need to know before making a final decision.
- Most borrowers with a positive repayment history will see credit growth.
- Loans often come with lower interest rates than lines of credit.
- The repayment schedule is predictable and fixed.
- Fees may be higher for those with less-than-ideal credit.
- Interest rates on variable-rate loans can ebb and flow with the Fed’s behavior.
- Late or missed payments can have negative credit consequences.
What credit score do you need for an installment loan?
While each company and loan type will require different credit scores, it generally requires that borrowers have a minimum credit score in the mid-600s. However, those with credit scores in the mid-700s and 800s will be eligible for the most competitive rates and terms.
If you have a credit history with a good or less than stellar score, you may still be approved for an installment loan, but it may be more difficult to find a lender or company with relaxed eligibility requirements. While there are lenders that offer bad credit loans, the interest rates and fees are often on the higher side.