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If you’re looking to expand your new and thriving ecommerce company but don’t have the necessary capital, you might consider applying for a loan. Borrowing from friends and family isn’t an option for everyone, and finding an angel investor or venture capital backers can be challenging.
This is where an installment loan comes in. It’s a straightforward option for business funding, involving monthly payments over time. Here’s what you need to know about installment loans, including which ones work best for your needs and the long-term implications of getting one.
What are installment loans?
Installment loans provide a lump sum of money to borrowers, who then repay the loan in monthly payments, or installments, until the loan is repaid in full. Each installment payment includes a fraction of the principal—the money borrowed—plus interest.
Installment loans can have either a fixed interest rate or a variable interest rate. Fixed interest means your rate and monthly payments don’t change for the life of your loan. A variable-interest rate means your interest rate could change from month to month based on market conditions.
Banks, credit unions, online lenders, and other financial institutions offer installment loans. The most common types of installment loans include:
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Short-term and long-term business loans, including SBA loans
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Mortgages (home loans)
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Auto loans
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Personal loans
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Student loans
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Payday loans
Buy now, pay later installment loans
A variation of installment loans that some retailers offer is a buy now, pay later (BNPL) loan. BNPL options, like Shop Pay Installments, let consumers purchase products and repay through installments.
Typical programs require making four equal payments every two weeks. Unlike traditional installment loans, BNPL programs approve funding without triggering a hard credit check—when lenders review your credit report after you’ve completed a credit or loan application—and don’t require a credit report for approval.
Secured vs. unsecured installment loans
Standard installment loans fall into two broad categories: secured loans and unsecured loans. Mortgages and auto loans are secured installment loans. Home mortgage and auto lenders use your property or car as collateral to secure the loan. If you fail to make payments on a secured loan, your lender can seize the asset used for collateral. For business loans, you’ll likely have to put up collateral such as equipment, real estate, inventory, accounts receivable, or other assets.
In contrast, personal loans, payday loans, and student loans are unsecured installment loans. You don’t need to put up collateral to obtain a loan, but lenders heavily weigh other factors. This includes your credit score, credit history, income level, other debts, and whether you repaid loans in the past.
Credit made available through a business credit card is another type of unsecured loan. BNPL loans are also unsecured. Merchants get paid by the BNPL lender, and customers, in turn, pay installments to the BNPL company until they’ve paid back the balance.
Factors that impact installment loan terms
Although there’s no set standard set of factors that each lender follows when evaluating installment loan applications, they do consider some or all of the factors below when reviewing your installment loan application.
Credit score and history
Your credit score and history are critical for loan qualification and determine your interest rate. Lenders who make secured and unsecured installment loans consider your creditworthiness for approval.
The higher your credit score, the better chance you have of qualifying for a loan with the lowest interest rate available. The lower your credit score, the less chance you have of being eligible for a loan. If you do qualify, you may not get the full amount you need, or you might have a higher interest rate compared to someone with a good or excellent credit score.
Your credit score is a three-digit number—850 is generally the highest—that credit bureaus use to assess your creditworthiness. Credit bureaus such as Equifax, Experian, and TransUnion evaluate factors including:
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Payment history. On-time debt payments are crucial to improving and maintaining your credit score. Generally, the more on-time payments you make, the higher your score; the more you miss, the lower your score.
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Credit utilization. This is how much credit you’re using out of how much is available. If you max out your available credit, this tells lenders you’re financially overextended, and it might be too risky to lend to you.
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Credit history. The longer your accounts are open, the higher your score. As newer accounts age, your score goes up, provided you repay your obligations on time.
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Credit mix. This includes revolving credit (not a type of installment loan), mortgage loans, auto loans, and all types of credit you have. The more diverse your credit mix is, the higher your score. Your credit mix is a small, but still important, part of your score.
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Recent credit activity. Completing new applications that trigger a hard credit inquiry can cause your credit score to drop temporarily. A single hard inquiry has a minimal impact on your score, but many hard credit checks in a short period could lower your score.
Income
Whether you’re taking out a business or personal installment loan, lenders generally look at your income to determine if you can reliably make monthly installment payments. Business owners typically need to do considerably more, like providing financial documents such as bank statements, revenue projections, and tax returns.
Newer companies with a short financial history may have a harder time qualifying for some business loans compared to companies that have been around for a few years and have stable finances.
Debt
How much debt you or your business has affects how much you can borrow and for how long. Lenders look at your debt-to-income ratio (DTI) to see how your monthly debt obligations compare to your monthly earnings, expressed as a percentage. Each lender has their own DTI requirements, but the lower your DTI ratio—typically 35% or less, according to Experian—the higher your approval odds.
Loan amount
How much you want to borrow plays a role in your approval odds, loan terms, and interest rate. Some lenders have minimum and maximum limits on how much you can borrow. You may not get approved if you need to borrow more than the lender’s ceiling, or you might get approved for only part of the amount you’re seeking.
Length of loan
Your repayment terms include how long you have to fully repay your loan. Each lender has term limits, so if you need longer terms, some lenders may turn you down. If you qualify with shorter terms, you will have to make larger monthly payments for a given loan amount than you would for a longer term, but you may save on interest during the life of the loan.
How do installment loans affect your credit?
Installment loans can help or hurt your credit score, depending on how you manage your debt:
1. On-time payments. Making installment loan payments on time every month shows you’re a responsible borrower, which boosts your score.
2. New credit. Completing new installment loan applications causes your score to dip, but it goes up after a few months of on-time loan repayment.
3. Additional debt. Taking on an installment loan increases the total amount of debt you have. Your DTI ratio goes up, and so does your credit utilization. High credit usage tells bureaus you may have more debt than you can repay.
What happens if you miss an installment loan payment?
Each lender handles late payments differently. If you miss an installment payment, your loan immediately becomes delinquent, unless your lender has a grace period. You could face late fees if you miss paying by your regular due date and grace period.
After 30 days, a lender will typically report your missed payments to credit bureaus. Payment history is a significant factor in your credit score. Negative marks from late payments can stay on your credit report for as long as seven years. If you continue to miss payments, your lender could turn your loan over to a debt-collection company, and your score could continue to drop, making it more difficult to borrow additional money in the future. As a last resort, a lender may seize your collateral if the loan is secured.
What are installment loans FAQ
What is an example of an installment loan?
There are a few different types of business installment loans, including SBA loans, startup loans, equipment loans, and invoice financing.
Do installment loans hurt your credit?
When you complete an application for an installment loan, it triggers a hard credit inquiry that can temporarily lower your credit score. After a few months, your score can rebound, as long as you’re making on-time payments on your new loan. Your score can continue to decline if you don’t.
What is the difference between an installment loan and a regular loan?
An installment loan is a regular loan, usually with a fixed-interest rate and the same monthly installment payments for the life of your loan.
*Shopify Capital loans must be paid in full within a maximum of 18 months, and two minimum payments apply within the first two six-month periods. The actual duration may be less than 18 months based on sales.
