An installment loan is any type of loan for which you receive the principal all at once and repay it with interest through monthly payments called installments.
The term covers a variety of loans, including student loans, personal loans and mortgages. Let’s explore the details of installment loans so you can decide if they’re the right choice for your financial situation.
How does an installment loan work?
How the loan works will depend on the type of installment loan.
Unlike a line of credit, with an installment loan, borrowers typically receive a lump sum amount. With some installment loans, like mortgages, the amount goes toward buying something specific (in this case, a house). With others, like personal loans, borrowers typically receive the funds as cash. Once you repay the loan, the account is closed.
Installment loans can be secured or unsecured. Secured loans require the borrower to provide collateral, such as a house or car, to “secure” the loan. If the borrower cannot repay the loan, the bank may repossess the collateral to recover the amount owed.
Unsecured loans do not require collateral. Instead, the lender evaluates the borrower’s creditworthiness and income to determine their eligibility. Because lending without collateral can be riskier for banks, they may charge a higher interest rate.
Installment loans can have a fixed or variable interest rate. A fixed rate stays the same over the life of the loan while a variable rate can change. Having a variable rate loan means the monthly payment amount can also vary.
In general, eligibility for an installment loan depends on factors like your creditworthiness and income, which can also influence the terms.
Types of Installment Loans
Many different credit products fall under the umbrella of installment loans, but all involve a one-time disbursement of funds and repayment in installments.
Here are some common installment loans.
Fixed Rate Mortgages
A mortgage is a secured installment loan that allows you to purchase property, with the property functioning as collateral. Borrowers typically repay fixed-rate mortgages in fixed monthly payments over 15 to 30 years. Eligibility and loan terms are subject to the borrower’s creditworthiness and income. The property’s appraised value may also determine some of these factors.
Adjustable Rate Mortgages
Adjustable Rate Mortgages (ARMs) typically start at a lower rate, but change over time based on financial market conditions, meaning the rate can go up or down. These changes are then reflected in your monthly payment. For example, if your rate goes up, so will your payment. In some cases, ARMs are capped to limit your monthly payment from changing too much.