6 Pros and Cons of Installment Loans

Installment loans offer financial flexibility.

There are many ways to borrow money. If you have a credit card that you use to pay for expenses, you're borrowing money from the credit card issuer. When you make your monthly payments, you're repaying that loan. Credit cards are an example of revolving credit, which is when you have a line of credit you can use many times over.

But another common type of credit is installment credit. If you're borrowing money this way, sometimes you're using the money for a specific purpose (such as to buy a home, in the case of a mortgage loan). This is a secured loan. There are also unsecured installment loans, which include personal loans. You can use the funds from a personal loan for whatever you want. With this type of credit, you're paying the money back over time, in installments. Here's how these loans can impact your finances, for good and for ill.

Pro No. 1: You can finance a large purchase

Installment loans give you the change to make a large purchase and pay it off over time. This could make buying a car or home possible for you if you don't earn enough money or have enough savings to pay for it outright. While recent home price gains have made it harder for the average American to buy a home, at least having access to a mortgage loan means that it is still possible for some. The median home sale price in Q4 2022 was $467,700, according to the Federal Reserve Bank of St. Louis. That's a lot of money to save up for an all-cash home purchase.

Pro No. 2: They're an opportunity to improve your credit

Installment loans give you the chance to build your credit. How so? Your payment history makes up 35% of your credit score, and if you resolve to make every single payment on your installment loan on time and in full, your credit will improve over time. This is one of the easiest ways to increase that three-digit number that impacts so much of your financial life.

Pro No. 3: The payment amount stays the same (generally)

Revolving credit, like your credit card, doesn't offer fixed payments or fixed interest rates. Your payment on an installment loan, however, does generally stay the same month after month. This makes it much easier to budget for those payments. The exception here is if you've signed on for an adjustable-rate mortgage, in which case your interest rate will change, meaning your payments will change too.

Con No. 1: You're locked in for the length of the loan

It's not all sunshine and roses with installment loans. One thing to keep in mind is that when you get one, you're locking yourself in for the length (and amount) of the loan term. If you've agreed to borrow, say, $10,000, and to pay it back over a term of five years, you've committed to make those payments. And none of us have any idea what life has in store for us, be it good or bad. Anything that happens over that five-year period could impact your ability to pay back the loan.

Con No. 2: If you miss payments, it could hurt your credit score

If you have difficulty making the payments (say, because you are laid off from your job and don't have enough cash savings to keep up with your bills until you get a new one), your credit score could be at risk. Remember our discussion above about how making on-time payments can improve your score? The converse of this is also true, and if you pay late or skip payments altogether, your lender could send the debt to collections and your credit score will take a big hit.

Con No. 3: You may be subject to prepayment penalties

If your finances improve during the loan term, you may be thinking that you can just rush to pay off the loan sooner (which would also save you on interest). But watch out! Some lenders charge prepayment penalties to make up for the loss of revenue from you avoiding paying additional interest. It's important to read the fine print on your installment loan (or ask the lender) to make sure you won't incur these fees if you get out from under your debt early.

Installment loans can be a win for your finances and your life -- but they can also have a negative impact, depending on how they're managed. Armed with this information about installment loans, you're now ready to finance your next big purchase or even get a loan to start your own business.