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Installment credit is simply a loan you make fixed payments toward over a set period of time. The loan will have an interest rate, repayment term and fees, which will affect how much you pay per month.
Common types of installment loans include mortgages, car loans and personal loans. Like other credit accounts, timely payments toward installment loans can help you build and sustain strong credit scores. Your credit scores will dictate whether you qualify for an installment loan, and your interest rates and terms if you do.
Here's what you need to know about installment loans, how they work and how they affect your credit.
How an Installment Loan Works
When you take out an installment loan, you borrow a fixed sum of money and make monthly payments of a specific amount until the loan is paid off.
An installment loan can have a repayment period of months or years. Its interest rate could be fixed or variable, meaning it can go up or down in the future. Installment loans also may come with additional fees, such as origination or late fees. It's crucial to check the loan agreement carefully before taking out an installment loan to understand exactly how much you'll pay.
Typical installment loans include:
- Mortgage: A mortgage is a loan used to buy a home. The home itself acts as collateral, so if you're unable to make payments, your lender could take possession of it. Mortgages generally come in 10-, 15- or 30-year terms, and will have either a fixed or adjustable interest rate. You'll also pay closing costs, fees and, potentially, private mortgage insurance if your down payment covers less than 20% of the purchase price of the home.
- Car loan: Like mortgages, car loans typically require a down payment. The more you put down, the smaller your installment loan will be. A car loan uses your vehicle as collateral, similar to a mortgage, meaning your car could be repossessed if you don't pay the loan as agreed. Car loan terms are typically 36 to 72 months, but longer terms are becoming increasingly common. As of the first quarter of 2019, 38% of new passenger vehicle loans had terms of 61 to 72 months, according to Experian data.
- Personal loan: A personal loan can be used for many purposes, including consolidating debt or financing a home renovation. Personal loans are unsecured, meaning they're not backed by collateral like mortgages or car loans are. As a result, their interest rates can be high—up to 36%—depending on your credit scores. You can generally take out a personal loan between $1,000 and $50,000, with repayment terms of two to five years.
How Are Installment Credit and Revolving Credit Different?
Unlike an installment credit account, a revolving credit account lets you carry a balance from month to month. Credit cards and home equity lines of credit are examples of revolving accounts.
On a revolving credit account, you decide how much to charge every month and how much to repay. When you carry a balance from month to month, the interest you'll incur adds to your total balance.
While you aren't required to pay off the full balance each month, the lender will provide a credit limit, or maximum amount you're allowed to charge. It will also assign you a minimum monthly payment, which can change depending on your balance. If you miss payments or you're late, your credit score will suffer.
Do Installment Loans Build Credit?
Making installment loan payments on time is one of the primary ways you can build and improve your credit. Payment history is the largest contributor to your credit score; making on-time payments demonstrates to lenders that you're a responsible user of credit.
While paying an installment loan as agreed and in full will have a positive effect on credit scores, paying off the loan early likely won't have a significantly greater impact than simply paying it off on time.
Unlike a revolving account, such as a credit card, once an installment loan is paid off, it's considered closed. A closed account in good standing will stay on your credit report for 10 years and will continue to benefit your score.
The Bottom Line
Installment loans can help you achieve some of the most common and sought-after financial goals, like owning a house or car, by allowing you to pay back a purchase over a long period of time. Making installment loan payments on time and paying off the loan as agreed will help your credit.
But like any type of credit, only seek out loans you really need, and check your credit score before applying to see what interest rates you'll likely qualify for. If needed, take some time to improve your credit score before you apply to ensure you get the best rate and terms possible.