What Is an Installment Plan?

An installment loan is a lump sum amount of funds that you can use to make a purchase. After you take out the loan, you need to make regular payments over the loan term to repay it. The payments are called installments so that is where the term installment loan comes from.

When you are approved for an installment loan, you’ll receive a lump sum payment upfront. In some cases, you’ll receive the cash to spend however you want. In other cases, the lender may send the funds directly to cover the purchase.

Once the funds are dispersed, you will need to make payments at regular intervals in set amounts. The payments include the principal amount you owe on the loan plus the interest payments. In most cases, you will make monthly payments, but the payment schedule can vary based on the lender.

The regular payments continue for the duration of your loan term. It is the amount of time that you agreed to when you signed the loan documents. Installment loans can be used to cover several purchases such as mortgages, personal loans, and car loans.

Installment Loans vs. Revolving Credit Options

The two major types of borrowing options are installment loans and revolving credit.

Unlike an installment loan, revolving credit is associated with an open line of credit. You will be able to make charges against the credit at any point, up to a specific limit. With that, you will find that the monthly payments vary dramatically and can be difficult to budget for. However, you’ll have the convenient ability to borrow more when you need it.

A credit card is an example of revolving credit. You can make charges throughout the month but when your bill comes, the total amount due will vary based on your charges made that month.

Secured vs. Unsecured Installment Loans

Installment loans come in both secured and unsecured loans. Unsecured installment loans do not require collateral. You will not be required to attach any assets to the loan. The lack of collateral can make these loans for difficult to qualify for.

Mortgages and auto loans are secured installment loans. A secured loan requires that you put up an asset as collateral for the loan, which the lender has the right to take if you default on the loan.

Secured installment loans have better interest rates but unsecured installment loans come without the risk of losing an important asset, like your home or car.

Pros and Cons of Installment Loans

Keep in mind the following advantages and disadvantages of installment loans.

Pros of installment loans

• Predictable payments: a regular payment can be easier to budget for and you will not have to worry about a surprise bill.
• Financing a major purchase: most of us cannot afford to fund a major purchase in cash. An installment loan can help you make the purchase and commit to an affordable payment plan.
• Possible to pay off the loan early: If you are able to, then you could save money on interest payments by paying off the loan early. Keep an eye out for early prepayment penalties if this is an option you want.
• Potential to build your credit score: your credit score can improve if you make on-time monthly payments for the course of the loan.

Cons of installment loans

• Potential to overborrow: an installment loan is disbursed at one time, so you need to know how much you need upfront.
• Potential to damage your credit score: If you miss payments, then you could hurt your credit score.
• High interest rates: If you have bad credit, you might struggle to find a loan with low interest rates.
• Sneaky loan fees: Watch out for origination fees and prepayment penalties that can increase the total cost of your loan.

The Bottom Line

An installment loan can help you cover the costs of a major purchase. The details of each loan will vary so you will be able to make set payments on a regular schedule. Take the time to shop around for the right lender to ensure the lowest cost and necessary features for your situation.