What Is an Installment Loan, and How Do You Use One?

Wise Loan Editorial Team
By: Wise Loan Editorial Team
a person calculates figures on a calculator for personal installment loans

One of the most prevalent forms of borrowing is an installment loan. Chances are, if you have any kind of debt, you probably have one or more installment loans. These loans encompass various categories, such as student loans, auto loans, and personal loans.

Let’s delve into the details of traditional installment loans and explore their various purposes.

What is an Installment Loan?

An installment loan is repaid through equal payments, spread out over a specified period. For instance, if you take out an auto loan for 60 months, you will make consistent monthly payments for a duration of five years. That’s the essence of an installment loan.

These loans are commonly used, and they differ significantly from revolving credit accounts.

A typical example of a revolving credit account is a credit card. With a credit card, you are given a credit limit, and as you use it, the available credit decreases until you make payments to reduce the debt. When you make payments, the credit becomes available again. This cycle of available credit and owed debt is what “revolves” in a revolving credit account.

Understanding Installment Loans and Their Usage

An installment loan comprises three primary components: the principal amount borrowed, the loan term’s length, and the interest rate applied to the borrowed money. These factors determine the monthly payments and the total cost of the loan. To illustrate how these elements interact, let’s consider a hypothetical example:

Let’s say a person borrows $5,000 for a personal loan with a term of three years, resulting in 36 monthly payments. The loan carries an interest rate of 9%. In this case, the individual would make fixed monthly payments of $159.00. Ultimately, the total amount repaid would be $5,723.95, signifying that the loan’s cost amounts to $723.95.

To demonstrate the impact of interest rates, let’s consider the same loan but with a higher interest rate of 12%. In this scenario, the monthly payments would increase to $166.07, and the total amount repaid over the loan term would be $5,978.58. Consequently, the higher interest rate would cost the borrower a bit over $200 in total.

Distinguishing Payday Loans from Installment Loans

Many people mistakenly assume that payday loans and installment loans are interchangeable, but they are distinct. Payday loans are short-term loans for relatively small amounts, intended to be repaid on the next payday. If unable to repay the loan on time, borrowers often have the option to roll it over for an additional fee.

Unlike installment loans that involve traditional interest rates, payday loans typically charge a flat fee for borrowing the money. For instance, borrowing $500 might incur a $75 fee. If the loan is rolled over, additional fees may apply. Due to these upfront costs and the immediate repayment requirement, payday loans tend to be more expensive than installment loans.

How to Utilize an Installment Loan

An installment loan can serve various purposes. To obtain one, you first determine the amount needed and the reason for borrowing. Subsequently, you apply for the loan.

Based on your creditworthiness, income, and existing debt, you may be approved for the loan at a specific interest rate, and upon approval, the funds will be provided. In-person applications may result in a check, while online applications typically transfer funds directly into your bank account.

Once you receive the money, you have the freedom to use it as needed or according to the loan’s specified purposes. Whether it’s making purchases or consolidating existing debts, the funds can be tailored to your requirements. In certain cases, such as funding education or purchasing a vehicle, the lender may directly provide the funds to the respective institution or dealership.

Common Types of Installment Loans

Installment loans are widely used for various purposes. Some common examples include:

  1. Auto loans: Whether for a new or used car, auto loans are structured as installment loans, usually ranging from five to eight years in term.
  2. Student loans: Government and private student loans are both considered installment loans, with interest rates set accordingly.
  3. Debt consolidation: Using an installment loan to consolidate higher-interest debts, such as credit card balances, provides the convenience of fixed monthly payments.
  4. Secured loans: Loans secured against assets like boats, ATVs, or jewelry work similarly to auto loans, where the purchased item acts as collateral.
  5. Unsecured personal loans: These versatile loans can be used for various expenses, such as medical bills or emergency situations, but often come with higher interest rates due to their unsecured nature.

Impact of Installment Loans on Credit

Managing an installment loan effectively can positively impact your credit score. Unlike credit card balances that can affect your credit utilization rate, maintaining an installment loan does not significantly reduce your credit score. Consistently making on-time payments demonstrates responsible financial behavior, which can help build and improve your credit history.

Applying for a Personal Installment Loan

Whether you need financial assistance during emergencies, wish to fund a vacation, or are looking to enhance your credit profile, a personal installment loan may be the solution. To explore your options and see what you qualify for, consider applying for a Wise Loan today!

The recommendations contained in this article are designed for informational purposes only.  Essential Lending DBA Wise Loan does not guarantee the accuracy of the information provided in this article; is not responsible for any errors, omissions, or misrepresentations; and is not responsible for the consequences of any decisions or actions taken as a result of the information provided above.

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About the Author

Wise Loan Editorial Team

Wise Loan Editorial Team

Introducing the Wise Loan Editorial Team – a collective of experienced finance and credit professionals dedicated to enhancing your financial path. Our team boasts over three decades of expertise in the finance sector, united in our commitment to deliver reliable and practical financial insights. True to the Wise Loan ethos, our goal is to positively impact the financial well-being of our customers.

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