What Are Installment Loans and How Do They Work?

December 6, 2024
When should I use an installment loan?

You’ve budgeted and saved, and you’re feeling good about your finances! You’ve got just enough to pay all your monthly bills with a little extra for a night out. And then… your car breaks down. Or you have to take an unexpected trip to the emergency room. Or your air conditioning decides to kick the bucket. Now there’s a hole in your budget you don’t know if you can fill with the cash you have on hand—what do you do?

Installment loans are a type of loan that lets borrowers repay the amount over time rather than all at once via a scheduled payment plan. This type of loan can be very helpful in covering sudden expenses. This guide will cover types of installment loans, how they work, how they can benefit you, and what to consider before applying for one.

What are installment loans?

What is an installment loan?

Installments loans are essentially borrowed funds that you (a) have access to all at once and (b) pay back in fixed installments. These fixed payments are determined at the time you take out the loan, and might be biweekly, monthly, etc. This means you know right off the bat exactly how much you owe, and at what times.

There are various types of installment loans that serve different purposes and may have varying interest rates:

  • Personal Loans: These versatile loans can be used for most expenses. Most often, they’re used for emergency funds, but they can also finance major events like adoptions, vacations, or weddings.
  • Auto Loans: These loans are specific to the purchasing of a vehicle. Where personal loans tend to be unsecured debts (and therefore have higher interests), an auto loan uses the vehicle in question as collateral.
  • Mortgages: Another type of installment loan with a fairly straightforward collateral is a mortgage. There are many mortgage options, and most have competitive interest rates, so research is your best friend when considering a mortgage loan.
  • Student Loans: An incredibly common option for financing a college education, these loans can be used not only for tuition but for college housing, food, supplies, etc. 42.8 million borrowers have federal student loan debt. The most common of these student loan options is offered through the FAFSA, though private loans are also available.

Installment loans function differently than other types of borrowing. Payday loans, for example, are usually smaller sums that are lent to you and then due on your next payday. Revolving credit—using a credit card—means the amount you borrow can be used at any time, and you can pay it back and borrow again. Generally, a credit card has a higher interest rate than an installment loan.

How do installment loans work?

How do installment loans work?

How do you go about getting an installment loan? Let’s break this down into four steps: 

  1. Application Process
    The first thing you’ll need to do is research. Make sure to consider more than one lender and look into their interest rates and potential repayment structures. The more thorough you can be in your research, the more prepared you’ll feel for taking out a loan. When you’ve selected a lender, you’ll be asked to fill out an application, which usually includes submitting documents like legal proof of identity and income.
  2. Loan Approval
    In consideration applications, lenders will look at your credit score, your income, and your debt-to-income ratio to determine whether you are a good fit for their loan offerings. Some lenders may have lower benchmarks for credit scores than others.
  3. Receiving Funds
    Once you’ve been approved for an installment loan, you’ll set up a payment plan and then receive the amount all at once, in a “lump sum,” to your designated account.
  4. Repayment Structure
    Your payment plan will detail the amount borrowed and divide it into payments due at fixed intervals, whether that’s biweekly, monthly, or another option. You’ll have established the loan’s interest rate before borrowing, so you’ll know how much is due at each payment until the loan is paid off. Loans are often amortized, meaning earlier payments are more interest-heavy—interest might decline as the “principal” amount, or the original amount borrowed is incrementally paid off.

What are installment loans used for?

Installment loans can cover a wide range of expenses. They’re often used for major purchases, like appliances or furniture, or taken out to assist with debt consolidation. As previously mentioned, they can also be a great option for emergency expenses. They are also commonly used to fund further education or training. 

To learn more about our installment loan offerings here at Credit Central, apply online and get started today!