What is an Installment Loan? How They Work & Examples

An installment loan is a loan that lets you borrow a lump sum of money and repay it with interest in regular installments over a period of time. Installment loans are the most common type of loan product available to consumers, but it’s important to understand what they are and how they work before you borrow.

What Are Some Examples of Installment Loans?

Examples of installment loans are mortgage loans, auto loans, student loans, and personal loans. The purpose of the first three types of installment loans are self-explanatory, but personal loans can be used for a variety of purposes, including:

• To consolidate debt
• To cover an emergency expense
• To finance a large purchase

How Are Installment Loans Different From Credit Cards?

Both installment loans and credit cards allow you to borrow money that you will eventually repay. However, they differ in terms of how the loan is repaid. For instance:

• With an installment loan, you repay the amount you borrowed in regular monthly installments until the entire debt is paid off.
• With a credit card, you can spend the money you borrowed (up to a particular credit limit), repay it and then borrow again on a revolving basis.

For these reasons, credit cards are considered “revolving credit,” while installment loans are considered “closed-end credit.”

How Are Installment Loans Different From Payday Loans?

A payday loan (also known as a payday advance) is a small, short-term loan intended to cover unexpected expenses that can’t wait until you receive your next paycheck. Payday lenders typically charge a fixed fee based on the amount of money borrowed, and you have until your next payday to pay off that amount plus the fee.

There are a few key differences between payday loans and personal installment loans. For one thing, installment loans are repaid over time through fixed bi-weekly, monthly, or semi-monthly payments, while payday loans are repaid all at once, usually within a few weeks of receiving the cash.

Because a lump sum is due relatively quickly, many borrowers find it difficult to repay a payday loan on time, leading them to extend or expand their loans. According to the Consumer Financial Protection Bureau, four out of five payday borrowers who roll over their loans end up reborrowing the same amount or more. Because most payday lenders charge renewal fees and bounced check charges, this can create a cycle of debt that’s tough to escape. Here’s a quick comparison of key differences between installment loans and payday loans.

How Do Installment Loans Affect Your Credit Score?

Much like credit cards, installment loans can impact your credit score if the lender you’ve chosen reports loan payments to a major credit bureau such as Experian, TransUnion or Equifax.

If you make your payments amount in full and on time, it may positively affect your credit score. If you miss payments or pay your bill late, especially by more than 30 days, it will negatively affect your credit score.

If you’re looking for steps to rebuild your credit score, a traditional installment loan isn’t usually recommended. However, you may want to consider a type of installment loan called a credit-builder loan.

What is a Credit Builder Loan?

Credit-builder loans are similar to secured credit cards in that they’re specifically designed to help you build, rebuild or improve your credit. With a credit-builder loan, you provide the loan amount to the lender as collateral, then pay it back in installments over time. Once the loan is paid off, you’ll get the deposit amount back, plus interest. And if you made all your payments consistently and on time, a credit builder loan  help increase your credit score.

What Are the Pros and Cons of Online Installment Loans?

People often turn to online installment loans because they’re relatively easy to obtain in comparison to other types of loans, and you can get the loan amount quickly, sometimes within minutes. However, just like any other credit product, installment loans have advantages and disadvantages. Whether or not an installment loan is right for you depends on your financial situation and specific needs.

Below are some of the pros and cons of installment loans.

How Do You Get an Installment Loan?

First, the basics. To apply for an installment loan, you’ll need:

• Government-issued ID.
• Proof of income.
• SSN (Social Security number).
• Some lenders may also require a checking account.

When shopping for an installment loan, it always pays to do your research. Rates and terms vary widely, so make sure to compare APRs and fees across multiple lenders before making a decision. You’ll also want to choose a loan with repayment terms that will work for you over the life of the loan, so that it fits your personal finances.

Can You Prequalify for an Installment Loan?

If you prequalify for a new loan, it simply means the lender has determined that you have a good chance of being approved. Prequalification gives you the opportunity to review your potential loan amount, terms and repayment period, usually without having a hard inquiry added to your credit report. This is done by the lender using a soft inquiry of your credit report and some basic information.  It allows the lender or lenders to get a better idea of your financial means. If you are prequalified your terms may change, or you may still be turned down after a complete review of your information.  Be aware though, most lenders will also run a full credit check if you decide to apply for a loan after you have prequalified. This involves a hard inquiry which does impact credit score.

What Are Some Installment Loan Alternatives?

If you’re unable to get an installment loan, only qualify for ones with less-than-ideal terms or simply want to avoid loans from traditional banks, here are some other loan options to explore.

Peer-to peer loan

A peer-to-peer loan — also known as P2P or social lending — allows you to borrow money from an individual investor or group of investors without going through a financial institution. P2P loans can be a good option if you’re looking for a way to pay off debt with a lower interest rate than other types of loans typically provide. However, one tradeoff is often an origination fee that can equal 1%-8% of your total loan amount.

Home equity loan

Home equity loans allow you to borrow money against the value of your house. If you have equity in your home, are looking for a lower interest rate, and are confident in your ability to repay the loan, this type of loan may be a good option.

Personal line of credit

A personal line of credit is a type of revolving credit. Similar to credit cards, personal lines of credit allow you to borrow (and repay) only the amount that you need. They're often used for long-term projects that have variable costs, which makes them a good option for projects without a specified price tag or end date.

Home equity line of credit (HELOC)

A HELOC works like a personal line of credit but is designed for people who own a home and have equity to borrow against. You typically can draw down the line of credit as you need for a certain period until the repayment term begins.

Salary advance

Some employers allow you to access some or all of your next paycheck ahead of your usual pay date. You won’t be charged any fees or interest for a salary advance, but you may be required to disclose personal details to your employer. In addition, some employers will only allow advances for specific qualifying expenses.

Borrowing from friends and family

This is an option if you have a friend or family member who’s willing to lend you the money you need. However, this type of “loan” can have just as many disadvantages as a loan from a financial institution — they’re just more likely to be personal ones. When borrowing money from friends or family, it’s still a good idea to put the terms of the loan into writing and stick to them.

Weigh Loan Options to Make an Informed Choice

Remember that all the alternatives to installment loans listed above come with their own set of pros and cons, and some require good credit for approval. Whatever type of loan you’re considering, be sure to research it thoroughly and read the fine print. If the loan terms aren’t a good fit then it’s a good idea to keep looking until you find a more suitable option.

At RISE, we believe everyone should have access to loans that meet their needs and support financial wellness. With a loan from RISEcredit.com, you borrow what you need, when you need it. And RISE provides free access to your credit score, helping you take control of your debt. Visit RISEcredit.com today to find out if a RISE loan is right for you.

This content provided is for educational and informational purposes only and does not constitute financial or legal advice. RISE is not acting as a credit counseling or repair service, debt consolidation service, or credit services organization in providing this content. RISE makes no representation about the reliability or suitability of the information provided – any action you take based on this content is at your own risk.