Common types of installment loans and their best uses

Key takeaways

• Installment loans can include mortgages, auto loans, personal loans and some types of home equity loans.

• Interest can be calculated at a fixed or variable rate.

• Some installment loans are unsecured, while others, like mortgages, are backed by collateral.

Unlike credit cards, installment loans are a type of close-ended debt, meaning you can’t borrow as you go. Instead, you borrow a fixed amount at the start of the loan and pay it back over several years. Monthly payments go toward principal and interest.

Because of their structure, you may be able to borrow more than you could with a credit card — often at lower rates. This makes installment loans a good option for large expenses like paying for school, buying a car or even purchasing a house.

5 most common types of installment loans

Installment loans are one of the most common ways to finance life’s bigger expenses. While they all operate similarly, the most common installment loans have different functions and interest rates.

Mortgages and auto loans are the most common installment loans. Almost everyone will have one or the other in their life, but you may also encounter personal loans, student loans and buy now, pay later loans. These are also popular — and often necessary — financing options.

1. Personal loans

Personal loans can be used for essentially every legitimate expense and are offered by banks, credit unions and online lenders. The best personal loan rates go to those with the highest credit scores.

Most personal loan lenders offer unsecured loans, which means collateral isn’t required. Because of this, personal loans tend to have higher interest rates than secured options, like mortgages or auto loans.

Some of the most common uses for personal loans include:

• Emergency expenses: Many lenders are able to fund loans as soon as the day after approval. This makes them a good alternative if you’re faced with an unexpected medical bill, an emergency car or home repair.

• Debt consolidation: A debt consolidation loan is a type of personal loan that allows you to roll multiple lines of high-interest debt into a single account with a fixed monthly payment. Getting a good debt consolidation loan rate can also save you a great deal of interest.

• Big-ticket items: While not recommended for every situation, large purchases and events like vacations, weddings and even home improvement projects can be financed with a personal loan.

There are many types of personal loans offered for nearly every expense — from weddings to adoption costs to vacation-related purchases. While most personal loan lenders place few restrictions on how to use the funds, not every lender or financial institution will offer loans for the same purpose. Make sure your needs are met before signing on the dotted line.

Who it’s better for

Personal loans are better for covering emergency expenses or projects with a high return. Because of their flexibility, you can get a personal loan for anything from a medical bill to an expensive car repair or even a home renovation.

2. Auto loans

Auto loans are meant specifically for purchasing a vehicle. While many dealerships offer in-house financing, you can also find direct auto loans through credit unions, banks and online lenders. They tend to offer lower rates and more repayment flexibility.

Before applying, conduct a financial audit and craft a repayment plan that works with your budget. Just like personal loans, auto loans tend to offer fixed interest rates — but they are a secured debt that uses your vehicle as collateral. If you default on your loan, the bank has legal authority to seize your vehicle to satisfy the delinquent debt.

Like personal loans, you will find car loans available through banks, credit unions and online lenders. Rates vary widely, and most lenders will offer lower rates for new cars. You may also benefit from a shorter term. It may make your monthly payment higher, but a lower interest rate could offset the added cost.

Who it’s better for

Since they cover the cost of a new or used vehicle, auto loans are a necessity for many people. If you don’t have the funds to buy a car outright, you will likely need to check your auto loan options.

3. Student loans

Student loans are used to finance a college education and related expenses like books, supplies, housing and food. Offered by the federal government and online lenders, 43.2 million borrowers currently hold student loans in the country.

The Education Department offers federal student loans through one streamlined application: the FAFSA. Federal loans are available to every borrower attending an eligible U.S. college or university, and they all have the same fixed interest rates. Due to the unique benefits and protections available to borrowers, it’s best to turn to federal loans before considering private lenders.

Private student loans base your approval odds and interest rates on your creditworthiness, and they can be difficult to qualify for as a student. Unlike federal student debt, private loans are disbursed by a number of different lenders. Each company will have different eligibility requirements and interest rate ranges, so shop around to make sure you’re getting the best student loan rate for your situation.

Who it’s better for

Federal student loans are the go-to option for financing your secondary education after grants and scholarships. Private student loans should be used only if there are college costs your federal loans can’t cover.

4. Mortgages

Mortgages are offered by a number of institutions, from national banks to credit unions to online lenders. There are five types of mortgages, including fixed-and adjustable-rate options, jumbo loans, government-insured mortgages and conventional loans.

Mortgages come in 15- and 30-year options. The 15-year option will allow you to build equity and pay down the loan faster. A 30-year mortgage, on the other hand, gives your wallet some breathing room in the short term by charging a lower monthly amount.

Unlike other, smaller types of installment loans, mortgages have some of the most competitive interest rates. They also have the most variety in their structure. Depending on the type of mortgage you qualify for, you may have a fixed or variable rate attached to your home loan.

Carefully research your options before choosing a lender. And if you already have a house, you can consider a home equity loan or second mortgage to finance big expenses like university costs and renovations.

Who it’s better for

Mortgages are another installment loan that many people will use during their lifetime. Because mortgages take different forms, you will need to do your research to determine which type of mortgage suits your home-buying needs.

5. Buy now, pay later loans

Buy now, pay later (BNPL) loans break up the cost of a purchase into installments, usually four, so that people can afford more than they otherwise would be able to. Most retailers — especially online retailers — now offer some form of BNPL as a payment option.

With a positive repayment history, BNPL loans often don’t charge interest or fees. They can be a convenient way to afford purchases without racking up credit card debt, and it can be easier to get approved for than a traditional personal loan.

There are different types of BNPL loans. Some companies require a hard credit check while others don’t, and almost none of the companies report positive repayment habits to the credit bureaus. Another potential downside of these loans is that borrowers may be tempted to borrow more than they can afford.

Before making a big purchase, ensure that you are able to make payments on the BNPL lender’s schedule. This will help avoid fees and keep you from overextending your finances.

Who it’s better for

BNPL loans may be appropriate if you have to cover a necessary expense like a piece of furniture. However, it may not be a wise financial move to use a BNPL loan on items that could be saved for.

Pros and cons of installment loans

Just like every other type of financing, installment loans have advantages and disadvantages that you should consider before making a decision.

Installment loans typically come with lower rates than credit cards and lines of credit. Plus, interest can be fixed, which makes payments predictable — and easy to calculate before you borrow. You could also see your credit score increase with on-time payments.

On the downside, if you have less-than-perfect credit, you could be stuck with higher rates and more fees, especially if you don’t shop bad credit loan rates before applying. If you have an installment loan with a variable rate, you could also see your payments increase and the amount that goes toward interest, depending on market conditions. Lastly, just like on-time payments can positively impact your credit, late or missed payments could negatively impact your score for years to come.

Next steps

Once you’ve identified the type of installment loan that best suits your needs, the next step is to compare lenders and terms. This includes checking each of the lender’s eligibility requirements, comparing interest rates, fees, and repayment terms.

Don’t rush into taking out a loan without thoroughly considering your options. Also, remember to only borrow what you can afford to pay back. Keep in mind that while installment loans can be a great tool to manage larger expenses, they should not be used as a long-term solution for financial problems.