What Are Installment Loans and How Do They Work?

What Are Installment Loans and How Do They Work?
Also called home equity loans, mortgages are loans that are exclusively for purchasing a home.
Photo
Point Editorial

Installment loans allow you to borrow a certain amount of money all at once. Afterward, you are required to pay it back through a set number of payments, also known as regular installments. Payments typically happen monthly. Installment loans are usually fixed as well, meaning the borrowed amount does not change over time. Loans that stretch over a more extended period come with higher interest rates. 

Installment credit may seem like a foreign concept, but it is more common than people realize. In fact, most loans that the majority of people have taken out are installment loans.

For more information on installment loans, read on.

Types of installment loans 

Described below are four of the most common types of installment loans. 

Personal loans 

Personal loans can go toward multiple endeavors, such as health emergencies or home renovations. Borrowers usually repay personal loans in regular installments spread out over one to eight years. Personal loans do not require collateral or up-front payments, unlike mortgage and auto loans. 

Mortgage loans 

Also called home equity loans, mortgages are loans that are exclusively for purchasing a home. Borrowers typically repay this type of loan in 15–30 years. Some mortgages have fixed interest rates, so they won't increase over the loan's lifetime, while others do. To determine the loan amount, simply subtract the home's market value from the amount left to pay on the actual mortgage. 

Auto loans 

Similar to taking out a personal loan, borrowers repay this type of loan in regular installments over 12 to 96 months. Although lenders consider your credit score upon application, there is no minimum credit score required to receive this type of loan. Just as mortgage loans use your home for collateral, auto loans do the same with your vehicle. So, if you are unable to pay back the loan, the bank can repossess your car.

Student loans 

Student loans are prevalent, especially among young people enrolled in college. Again, these loans are repaid in monthly installments. Unlike mortgages, for instance, you can delay paying student loans for a certain period after you graduate until you find employment. 

As unenjoyable as loan payments can be, they play a crucial role in establishing your credit history, which is beneficial in any bank's eyes. 

How does an installment loan work?

Step 1: Choose the best type of loan for you. Deciding this depends on the reason why you require the loan in the first place. After choosing your loan type, it is wise to compare loan options, as application conditions vary from lender to lender. 

Step 2: Apply for the loan. To do so, you’ll need personal information such as your address and your Social Security number, and financial information like income and a record of employment. 

Step 3: Use your loan.

Step 4: Pay your installments. To reiterate, this occurs regularly, typically once a month, and you will continue to pay until you’ve repaid the loan in full. 

The good and the bad of installment loans 

The following visual breaks down the main advantages and disadvantages of installment loans.

Benefits Drawbacks
Predictable payments make it easier to set and follow a budget.  Once the amount of the loan is decided, it cannot be changed. You need to make sure you know precisely how much you need before borrowing anything. If you’re looking for flexibility, you may want to look at other financial strategies. 
Installment loans provide you with an end goal. You’ll have far more peace of mind knowing that your debt will be completely repaid after a certain amount of time.  The loan's interest rates are based in part on your credit history. Credit scores that are fair or poor, compared to those that are good or very good, can hinder you from getting the loan. And, if you are approved, you’ll most likely face higher rates to make up for the risk.  
Installment loans allow you to pay off large purchases. Depending on the loan type, you can select the loan amount according to your needs.  
Your monthly installments can involve additional fees as well, like application fees and penalties for late payments. 

Secured versus unsecured installment loans  

A secured loan means that the borrower must pay collateral, while an unsecured loan means that collateral is not required, but you’ll have to pay more in interest as a result. Unsecured loans also heavily rely on the borrower’s credit history.

The maximum line of credit for a secured loan is up to you. For an unsecured loan, it is $50,000.

Moreover, a secured line of credit is often put toward more significant purchases, hence why a mortgage is the most well-known example. In comparison, lenders usually approve unsecured loans for more reasonable endeavors. 

FAQs

Do installment loans affect my credit score?

Yes, installment loans affect your credit score, but that impact can be either positive or negative. Payment history is the single most significant factor in your score calculations. Making timely payments will reflect favorably on your score.

Having different types of credit also factors into your score, so having a loan can be helpful not only in establishing your credit history but in diversifying it, too. 

How do you qualify for an installment loan?

The most effective way to increase the likelihood of qualifying for a loan is to build up a good credit history and credit score. But every loan is different, so it depends on the type of loan that interests you. Make sure you do your research or talk to a financial advisor, so you’re aware of any requirements. 

Point’s contributions 

The key to loans and their subsequent installments is knowing how to borrow and, in turn, how to spend wisely. By administering your money responsibly, you'll have sufficient funds to pay back lenders. Mastering the art of handling money responsibly is a skill that takes time to develop. 

With that said, let us introduce you to Point. Point Card is designed for those who want to spend their own money and earn rewards at the same time. Equipped with fraud protection and no interest rates, Point Card is a tool that gives you the freedom and opportunity to decide what your money goes toward, whether it's groceries, loan and bill payments, or a night out at the movies. Additional perks include cash-back on all purchases, plus bonus cash-back on subscriptions, food delivery, rideshare services, as well as car and phone insurance, and much more. 

Image Credits:
White House / Pixasquare
Orange House / Joss Woodhead

about the
author
Point Editorial
A group of writers, thinkers, & designers from varying backgrounds — all part of the Point Card team. Sharing perspectives on concepts in design, finance, and culture through an everyday lens.
PointCard
Made to spend.
BECOME A MEMBER FOR $99/yr.
Unlimited cash-back, exclusive rewards & comprehensive benefits.
Apply now
BECOME A MEMBER FOR $99/yr.

Additional Reading