What is an Installment Loan and How Does It Work

Mihai-Alexandru Cristea 15/12/2021 | 18:54

Installment loans have been around for a while, yet many people still don’t know a lot about them. Whether you’re someone with a background in loans and savings or you simply want to learn, you’ve come to the right place to get some answers! Installment loans are more common than you think, and you might find you already have a few of your own! To shed some light on the topic, here’s everything you need to know about installment loans, how they work, and why you should or shouldn’t get one. 

 

What is an installment loan?

An installment loan is a closed-ended credit account that provides the borrower with a fixed amount of money to be paid back over a fixed amount of time. You receive the money or item instantly after taking out the loan, then pay it back over a couple of weeks or years, depending on the installment loan. You pay off the loan with regularly scheduled payments called installments. The borrower will usually owe the same amount of money with each installment, which may include interest. 

With installment loans, you can only pay them off in installments and you can only borrow more money once you’ve paid everything back. This is different from other kinds of loans such as payday loans or a revolving credit account. Plenty of lenders offer these open-ended credit loans, that can be paid back more flexibly. Depending on what you need, are eligible for, or can afford to pay back, there’s a type of loan out there for you.

Types of installment loans

If you’re still unsure about installment loans or where you can find them in the real world, this list has got you covered. Here are the most common installment loans, found in everyday life, to give you a better idea. 

Student loans

Student loans are currently one of the most common kinds of installment loans out there. They provide a way for many students to get an undergraduate, graduate and other forms of higher education. They are unique because you don’t need to start paying them off right away. Many people often don’t start paying off their student loans until much later in life.

Mortgages

Mortgages are a type of installment loan, used by many future homeowners to make purchasing a house easier. Mortgages help people become homeowners and in return, they are required to pay back the value of the property with interest. There are plenty of different kinds of mortgages, but the most common ones need to be repaid over 15 to 30 years.

Auto loans

A popular installment loan for purchasing cars and automobiles is an auto loan. These loans can help individuals buy a new or used car by spreading out their payments over typically 2 to 7 years. Auto loans usually have a fixed interest rate which is something to keep in mind. 

Buy-now, pay-later loans

The buy-now, pay-later loan, also known as point-of-sale financing, is a common loan given out by retailers. You can buy household appliances, electronics, or even fashion with these loans and pay them back in a few installments. Depending on the retailer or the price of the item, your repayment time can last a few weeks to multiple years.

Personal loans

Personal loans are installment loans that don’t revolve around paying for a specific thing like a house or car. They can be used for consolidation of outstanding debt, car or home repairs, or paying an unexpected bill. Since the scope of these loans is so broad, finding a good one can be tricky. If you’re looking for inspiration, take a look at SFGate for recommendations to start with.

Why get an installment loan?

Like all types of credit, an installment loan comes with its own set of pros and cons. Whether or not it’s the right choice for you depends on your specific situation. Here are some pros and cons to consider when it comes to these particular loans.

Pros: 

  • Ability to cover large costs: The greatest thing about installment loans is that they can help you to afford large purchases. Installment loans give you instant access to pay off your student loans, home, or car payments with zero wait time.
  • Chances of refinancing: You can make your installments easier to pay off if your interest rates fall or your credit score improves during your payback period. This can either lower your monthly payment or make your repayment time shorter.
  • You know what to expect: The beauty of installment loans is that you know exactly what to expect for a period of weeks to years. Knowing exactly how much money you need to set aside to pay off your loan can help you budget and plan easier. 

Cons:

  • No open-ended loan benefits: Should you need to add money to your loan or to take out another one, you most likely won’t be able to with an installment loan. Close-ended loans need a little more financial planning to avoid any hot water. 
  • Potential interest rates: If your installment comes with added interest, you’ll have to be at the mercy of your credit score.  Lower borrower credit scores could mean higher interest rates which could mean that you’ll be paying more for your loan than you intended.
  • Potential long-term commitment: The payback period for some installment loans can stretch on for long periods of time. Before taking out the loan, make sure to read the terms and conditions, and don’t get into anything if you’re not ready for the commitment. 

So there you have it! Now you’re up to date and know exactly what an installment loan is and how it works. Installment loans are for those looking to take out a large amount of money, or an expensive asset, and pay it off in recurring installments. Whether it’s paying for a student loan, an auto loan, or a refrigerator in 4 installments, these types of loans can come in handy in a pinch. As with any loan, installment loans are not perfect and can be an expensive, long-term commitment. It’s important to do your research and to stay informed on everything from payday to installment loans! Now that you’ve learned all the basics of installment loans, you’re ready to go out there and take the world by storm!

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