arrow-left Back to resources

What Are Installment Loans and How Do They Work?

February 24th, 2024


Installment loans provide borrowers with a lump sum of financing upfront, which is then repaid over time through fixed, equal monthly payments over a set repayment term. Also sometimes called personal loans, installment loans offer predictable repayment schedules that allow borrowers to budget a regular monthly amount towards paying down principal and interest until the loan is fully paid off.

Unlike revolving credit like credit cards, the loan amount, length of term, interest rate, and monthly payment do not fluctuate over the life of installment loans. These key terms are fixed for the duration of the loan, providing stability for the borrower. Additionally, there are typically no penalties or fees for early or extra payments towards an installment loan’s principal. This structure allows borrowers to pay loans off faster if they choose by paying more than their monthly amount.

Common Uses for Installment Loans

From consolidating high-interest debt to funding major one-time expenses, here are some of the most common uses for online installment loans:

Debt Consolidation

One of the most popular uses for installment loans currently is credit card or consumer debt consolidation. Borrowers take out a lump sum personal loan at a typically lower and fixed interest rate compared to revolving credit card balances that fluctuate. This consolidated lump sum pays off existing debts, leaving the borrower with just one fixed monthly payment amount for the duration of the installment loan’s repayment term. Consolidation helps simplify complex finances with payments going in multiple directions each month.

Home Improvement Projects

Kitchen remodels, roof replacements, built-in pools, basement finishing, additions and more – large home renovation projects often cost tens of thousands of dollars or more all at once. Personal loans finance these expensive upgrades and allow homeowners to repay the costs over 1 to 7 years in predictable installments they can budget for.

Medical Procedures

Even for insured patients, medical bills for major elective procedures can leave large out-of-pocket expenses after health insurance pays its share. Fertility treatments, dental orthodontics, LASIK eye surgery, cosmetic treatments and more specialized healthcare costs often run from $10,000 to $40,000+. Installment loans make these life-changing procedures accessible and affordable through monthly payment plans tailored to individual budgets and needs.

Major Purchases

From buying and furnishing a new home, to investing in education through tuition and computers, to moving across the country for a new career, installment loans finance major purchases of all kinds for borrowers. These loans bridge financial gaps when savings and insurance coverage fall short.

Nearly any large one-time purchase, from celebratory life events like weddings to unfortunate emergencies like urgent home repairs, can be funded upfront then repaid over 12 to 84 months in predictable installments. This structure turns big one-time costs into more digestible monthly expenses.

The Many Benefits of Installment Loans

There are many advantages to installment loans that make them an attractive financing option for qualified borrowers taking on major one-time expenses:

Fixed Interest Rates

Installment loans lock in a set interest rate for the full repayment term. So even as market rates rise or fall over 12 to 84 months, that fixed interest rate holds steady. This protects the borrower from unpredictable rate fluctuations that might otherwise change their anticipated monthly payment and overall repayment costs over time.

Equal Monthly Payments

Each monthly installment payment made over the full loan term consists of both principal and interest in an equal, consistent amount. In the beginning of repayment more interest and less principal is paid off. But with every payment made, more of that fixed monthly amount goes towards paying down principal. Zero guesswork is needed because that payment stays the same until the loan matures and is ultimately paid off.

Fast Funding Timelines

Installment loan lenders now have application approval and funding down to a science - most of the process is automated for faster turnaround. Prequalification and approval often occurs in minutes. Once approved, loan funding typically takes just 1-3 business days. So borrowers get access to lump sums for major expenses incredibly fast these days.

Flexible Loan Amount and Terms

Every borrower’s financial needs and budgets are different. Installment loan amounts and terms provide solutions tailored to those unique needs and qualifications. Loan amounts span an estimated range of $1,000 to $100,000 in most cases.

Borrowers also get choices when it comes to repayment terms, selecting anywhere from 12 months for smaller loans up to 7 years (84 months) for larger balances. Navigating major purchases or healthcare costs gets more convenient as monthly payments align with reasonable budgets.

No Prepayment Penalties

Life happens - sometimes financial circumstances improve faster than anticipated allowing borrowers to pay down debts quicker. Installment loans encourage this behavior. Paying more than the monthly payment and paying loans off faster than originally planned comes with no early repayment penalties or fees.

Potential Credit Score Boost

Making consistent on-time installment payments faithfully each month demonstrates financial responsibility. In turn, this good payment behavior can get reported to major consumer credit bureaus. With higher credit utilization paid down and reliable repayment histories established over 12-84 months, installment loans may help build borrower credit scores over time. This makes other financing opportunities more accessible for borrowers later on.

Drawbacks and Considerations

Installment loans also come with a few drawbacks like most financing instruments that borrowers weigh when assessing their options. The main considerations are:

Hard Credit Inquiries

Many installment loan lenders do complete a hard inquiry into applicants’ credit reports before approving applications. Too many hard inquiries over a short period can negatively impact credit scores temporarily. So, applying only for needed loans is wise.

Interest Accrues Over Time

Just like any loan, interest starts accruing immediately when funds are dispersed. Avoiding interest costs altogether is impossible, though total costs compound faster on longer-term installment loans. Keeping loan terms on the shorter end minimizes interest paid.

Sufficient Income Is Required

Documented recurring income sufficient to cover payments is key in loan approvals. Fluctuating or limited incomes characteristic of unemployment, part-time work, freelancing etc. often fall short of installment loan qualification requirements. Steady full-time income helps ensure low delinquency risk.

Late Payments Damage Credit & Incur Fees

Missed or late installment loan payments hurt borrower credit while also incurring hefty lender late fees making repayment costs even higher. Falling behind on payments equates to failure to make financial obligations as promised – a major red flag for credit reporting agencies and future lenders.

Weighing if an installment loan aligns well with your borrowing needs and ability to consistently keep up with monthly payments is an important self-check before moving forward.