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What is an Installment Loan and How Does it Work?

November 25, 2019 by Daniel Azzoli

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When it comes to borrowing money, there isn’t a ‘one-size-fits-all’ solution. There are plenty of different loans available that are suited to different scenarios, but there are a few overarching categories we can typically assign them to. One of these is installment loans, which involves you borrowing money from a financial institution and paying this money back, along with interest and/or fees as applicable, over the course of multiple payments. But what is an installment loan exactly, and how does an installment loan work?  

 

Defining an Installment Loan

As we’ve already mentioned, at their base, installment loans allow people to borrow a set amount of money, which they then must pay back usually with interest and/or fees. This stands in contrast to revolving credit, which allows individuals to continuously borrow money against their loan limit as long as they have available credit and they’ve paid off what they owe.

With installment loans, you’ll generally be given a lump sum of money, pay this off over a series of installments (hence the name, “installment loans”), and then your loan will be closed. This means you’ll need to apply for a new loan if you want to borrow money again. The terms and the length of your loan will vary from lender to lender.

Typical Installment Loans

There are a few different types of installment loans out there, some of which you may have already used before. We’re going to break down some of the most common types.

Auto Loans

An auto loan (or car loan) is basically what it sounds like: It’s a personal installment loan that is taken out to help you pay for a car. And just like other installment loans, you’ll pay back the money you borrowed with interest and/or fees over the course of several months, typically between 24 and 84 (although this can vary).

Person driving a car

While a longer loan term may shrink the size of your payments by spreading them out over a longer period of time, you may end up paying more in the long run because of the increased amount of time in which you’ll be paying interest. For example, the size of your payments on an 84-month loan may be smaller than payments on a 36-month loan, but you may be paying more interest over the course of the 84-month loan.

It’s also important to note that auto loans may fall under the category of a secured loan, which means you’ll need to provide some form of collateral to the lender in order to be approved for the loan. With auto loans, the collateral is often the car you’re buying. This means that if you can’t keep up with your payments, your car may be repossessed and sold to cover your debt.

Mortgages

If you’ve ever purchased a home, there’s a chance you may already be familiar with the ins and outs of a mortgage. But for those who aren’t, mortgages are installment loans that people take out to purchase a home. Like we mentioned with auto loans, mortgages are secured, and in this case, the collateral provided is the home you’re purchasing.

The length of a loan can vary, but they’re generally repaid over 15 or 30 years. Just like with auto loans, a longer repayment term may mean lower monthly payments, but it also means you’ll be paying more interest over the course of your repayment period. If you want to get a better idea of what this looks like, play around with a mortgage calculator and see how your total monthly payment and total interest paid fluctuates as you change the length of your loan.

White house with red door and white picket fence

It may be easier to project the cost of a mortgage over its lifespan when it’s a fixed-rate mortgage. This means that the interest rate will stay the same over the course of the loan. This is different from an adjustable-rate mortgage, where interest rates change over the duration of the mortgage based on the market.

Personal Loans

Personal installment loans fall into a broad category of personal loans that can be used for a number of different things. The repayment period for these loans will often be between 12 and 60 months, although this can vary depending on the lender.

Unlike the types of loans we mentioned earlier, a personal loan may often be unsecured. This means that while you won’t have to put up any collateral, interest rates may generally be higher.

A personal loan is often best served as a way to deal with an unexpected emergency expense when you don’t have the savings to cover it on your own. For example, maybe you pop a tire while driving and need your car for your commute to work every day, or you have to take an unexpected trip to the emergency room. In both cases, if you don’t have the money to handle them, a personal installment loan may be able to help.

So, where do you apply for these loans? You can go the traditional route and look to a bank or credit union, but an online direct lender is another option that may be worth exploring. They may offer short term loans online that may have a more streamlined application process than certain other financial institutions.

Benefits of Installment Loans

Now we’re going to take a look at some of the benefits of installment loans, including their fixed predictable payment amounts, making things easier to budget, and allowing the opportunity to pay off debts.

Easier to Budget

calculator sitting on top of a spread sheet for someone’s budget

One of the benefits of a predictable payment schedule is the fact that it may make it easier for you to incorporate your debt payments into your regular budget. Since you’ll know how much you need to pay on your loan every month, you can focus on setting the same amount of money aside on a monthly basis to pay off your loan.

Also, when you have a set schedule of payments laid out before you, they may be easier for you to manage. Your payments will be spread out over a period of time which may make things more manageable and convenient.

But before you even take out a loan, you’ll need to make sure that the payments you’ll be making won’t break your budget. You should never take out a loan you can’t afford.

Paying off Your Debts

The repayment structure of Installment loans also give you the opportunity to pay them off by a pre-determined date. When you’ve got a clear end-date in sight, you’ve budgeted accordingly, and you’re confident that you’ll be able to pay off your loan, there’s an added comfort level in seeing the finish. Because a fixed-rate installment loan is relatively predictable, this may give you the motivation you need to keep up with your payments.

Your Installment Loan

So, what is an installment loan? We hope we’ve been able to answer this question for you and provide you with an installment loan definition that’s given you a better insight into what they are and how they’re used. In summary, installment loans involve borrowing money from a financial institution and paying them back with interest and fees over a series of pre-determined payments.

There are a number of different types of installment loans that are used in a variety of situations, so it’s important to know what options are out there and understand the differences between them.

If you’re facing an unexpected emergency expense and don’t have the savings to cover it, MoneyKey offers online loans (including installment loans) that may be able to help!


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