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

Liliana Pantoja
Liliana Pantoja
a person calculates figures on a calculator for personal installment loans

One of the most common types of loans is the installment loan. If you have any sort of debt, chances are that you have one or more installment loans. They can include student loans, auto loans and personal loans.

Find out more about traditional installment loans and what you can use an installment loan for below.

What Is an Installment Loan?

An installment loan is one that you pay back in equal installments over a certain period of time. For example, when you take out an auto loan for 60 months, you make an equal payment every month for a period of five years. That’s an installment loan.

Installment loans are a common type of credit, and they differ significantly from revolving credit accounts.

A revolving credit account example would be a credit card account. With a credit card, you have a credit limit of a certain amount. As you use that credit, you have less available credit you can use unless you make payments to pay off the debt. When that happens, you have more credit to use again. In this way, how much credit you have available and how much debt you owe “revolves.”

Example of an Installment Loan

The major components of an installment loan are typically how much you borrow (e.g. the principal), the length of the term and the interest rate at which you borrow the money. Those details determine how much you will pay each month and how much the loan will cost you in total.

To understand how all these factors work together, consider the hypothetical example below.

A person borrows $5,000 for a personal loan for three years. That means they will make 36 monthly payments. Their interest rate is 9%.

In this case, the person would make monthly payments of $159.00 per month. The total amount paid back would be $5,723.95, which means the loan would have cost them $723.95.

To understand how these factors work together, consider the same exact loan for someone who was offered an interest rate of 12%. In that case, the person would pay $166.07 per month. The total paid back would be $5,978.58, which means the extra interest points would cost them a bit over $200 in total.

Is a Payday Loan an Installment Loan?

Many people mistakenly believe that payday loans and installment loans are the same thing, but they are not. Payday loans are very short-term loans for relatively small dollar amounts, and they’re meant to be paid back the next time you get paid. If you can’t pay the payday loan out of your next paycheck, you often have the option to roll it over into a new payday loan at an extra fee.

Payday loans don’t have traditional “interest.” Instead, you typically pay a flat fee to borrow the money. For example, if you borrow $500, you may pay $75 for the benefit of doing so. If you roll the loan over again, you might end up paying another fee.

Because these loans have a flat fee and are typically due to be paid off immediately upon receipt of your next paycheck, the up-front costs tend to be quite a bit more than those of an installment loan.

How Do You Use an Installment Loan?

You can use an installment loan for a variety of purposes. To access one, you decide why you need to borrow money and how much you need. Then, you apply for the loan.

Based on your credit and other factors, such as how much you make and how much other debt you have, you may be approved for the loan at a certain interest rate, at which point the creditor will provide you with the funds. If you apply in person, the funds might come in the form of a check. If you apply for an installment loan online, the funds are typically transferred into your bank account.

Once you receive the money, you may use it as you see fit or according to the purposes laid out in the loan. You might make purchases with it or pay off existing debt, for example. In some cases, you might have borrowed money for a very specific purpose, such as to fund your education or buy a car. In those cases, the lender might provide the funds directly to the car dealership or school.

In any case, you would begin paying off your installment loan in the near future.

Common Types of Installment Loans

Many people are already familiar with installment loans because they are so common. Here’s a quick look at some of the most common uses for installment loans.

  • Auto loans. All car loans are installment loans, whether you’re buying new or used. Typically, the term for a car loan ranges from five to eight years, though in some cases you might borrow money for a lesser term. If you’re borrowing money for a relatively inexpensive used car or you can afford to make a large down payment, for example, you might only need three years to pay off the total.
  • Student loans. Whether you’re getting a government student loan after filing a FAFSA form or going with a private lender, your student loan is an installment account. Government student loan interest rates are set each year and don’t rely on credit histories. Private loans for school do rely on credit history, and the interest you pay could be impacted by your credit score.
  • Debt consolidation. If you owe higher-interest debt, such as a credit card balance, you may be able to get an installment loan to pay off that debt. By consolidating your debt with an installment loan, you can spread your payments out over time and work with a known, fixed monthly payment. The downside is that you either have to close the credit card accounts or have the willpower not to use them, or you could run them up again and have double the debt you started with.
  • Other secure loans. You can also take secure installment loans out on a variety of things, including recreational vehicles, such as boats or ATVs, or expensive jewelry. These work similarly to auto loans in that the item you purchase with the loan is security for the loan. If you don’t make your monthly payments, the creditor can repossess the item and sell it to help cover some of its losses.
  • Unsecured personal loans. Personal loans can be used to cover a wide variety of expenditures, including old debts, medical bills or emergency expenses. They aren’t secured with a specific item, which generally means you might pay more in interest because the lender is taking more risk.

How Does an Installment Loan Impact Your Credit?

An installment loan can be good or bad for your credit, depending on how you manage it. Unlike credit card balances, which can raise your credit utilization rate and cause your score to come down a bit, simply holding an installment account won’t reduce your score much or for long.

And if you make your payments regularly, an installment loan can benefit your credit. It demonstrates to future lenders that you do make your payments as agreed. For many people, this is one reason that they take out an installment loan — to help build their credit.

Apply Today for a Personal Installment Loan

Whether you need more money to make ends meet in a time of emergency, want to cover the cost of an upcoming vacation or simply need some additional accounts to build your credit, a personal installment loan may be just what you’re looking for. Find out what you can qualify for by applying with 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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