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You may feel proud of yourself for paying off a debt early, but doing so could trigger prepayment fees (ouch). The best way to avoid those charges is to read the fine print before you take out a loan that involves this kind of fee.

If you neglected to do that, however, it doesn’t necessarily mean you’re stuck with a prepayment penalty. Read on to learn ways to avoid paying loan prepayment penalties.

What Is a Prepayment Penalty?

A prepayment penalty is when a lender charges you a fee for paying off your loan before the end of the loan term. It can be frustrating that a lender would charge you for paying off a loan too early. After all, many people may think a lender would appreciate being repaid as quickly as possible.

In theory, a lender would appreciate getting repaid quickly. But in reality, it’s not that simple. Lenders make most of their profit from interest, so if you pay off your loan early, the lender is possibly losing out on the interest payments that they were anticipating. Charging a prepayment penalty is one way a lender may recoup their financial loss if you pay off your loan early.

Lenders might calculate the prepayment fee based on the loan’s principal or how much interest remains when you pay off the loan. The penalty could also be a fixed amount as stated in the loan agreement.


💡 Quick Tip: Before choosing a personal loan, ask about the lender’s fees: origination, prepayment, late fees, etc. SoFi personal loans come with no-fee options, and no surprises.

Can You Pay Off a Loan Early?

Say you took out a $5,000 personal loan three years ago. You’ve been paying it off for three years, and you have two more years before the loan term ends. Recently you received a financial windfall and you want to use that money to pay off your personal loan early.

Can you pay off a personal loan early without paying a prepayment penalty? It depends on your lender. Some lenders offer personal loans without prepayment penalties, but some don’t. A mortgage prepayment penalty is more common than a personal loan prepayment penalty.

Recommended: When to Consider Paying off Your Mortgage Early

Differences in Prepayment Penalties

The best way to figure out how much a prepayment penalty would be is to check a loan’s terms before you accept them. Lenders have to be upfront about how much the prepayment penalty will be, and they’re required by law to disclose that information before you take on the loan.

Personal Loan Prepayment Penalty

If you take out a $6,000 personal loan to turn your guest room into a pet portrait studio and agree to pay your lender back $125 per month for five years, the term of that loan is five years. Although your loan term says it can’t take you more than five years to pay it off, some lenders also require that you don’t pay it off in less than five years.

The lender makes money off the monthly interest you pay on your loan, and if you pay off your loan early, the lender doesn’t make as much money. Loan prepayment penalties allow the lender to recoup the money they lose when you pay your loan off early.

Mortgage Prepayment Penalty

When it comes to mortgages, things get a little trickier. For loans that originated after 2014, there are restrictions on when a lender can impose prepayment penalties. If you took out a mortgage before 2014, however, you may be subject to a mortgage prepayment penalty. If you’re not sure if your mortgage has a prepayment penalty, check your origination paperwork or call your lender.

Checking for a Prepayment Clause

Lenders disclose whether or not they charge a prepayment penalty in the loan documents. It might be in the fine print, but the prepayment clause is there. If you’re considering paying off any type of loan early, check your loan’s terms and conditions to determine whether or not you’ll have to pay a prepayment penalty.

How Are Prepayment Penalties Calculated?

The cost of a prepayment penalty can vary widely depending on the amount of the loan and how your lender calculates the penalty. Lenders have different ways to determine how much of a prepayment penalty to charge.

If your loan has a prepayment penalty, figuring out exactly what the fee will be can help you determine whether paying the penalty will outweigh the benefits of paying your loan off early. Here are three different ways the prepayment penalty fee might be calculated:

1. Interest costs. If your loan charges a prepayment penalty based on interest, the lender is basing the fee on the interest you would have paid over the full term of the loan. Using the previous example, if you have a $6,000 loan with a five-year term and want to pay the remaining balance of the loan after only four years, the lender may charge you 12 months’ worth of interest as a penalty.

2. Percentage of balance. Some lenders use a percentage of the amount left on the loan to determine the penalty fee. This is a common way to calculate a mortgage prepayment penalty fee. For example, if you bought a house for $500,000 and have already paid down half the mortgage, you might want to pay off the remaining balance in a lump sum before the full term of your loan is up. In this case, your lender might require that you pay a percentage of the remaining $250,000 as a penalty.

3. Flat fee. Some lenders simply have a flat fee as a prepayment penalty. This means that no matter how early you pay back your loan, the amount you’ll have to pay will always be the prepayment penalty amount that’s disclosed in the loan agreement.

Recommended: Debt Payoff Guide

Avoiding a Prepayment Penalty

Trying to avoid prepayment penalties can seem like an exercise in futility, but it is possible. The easiest way to avoid them is to take out a loan or mortgage without prepayment penalties. If that’s not possible, you may still have options.

•   If you already have a personal loan that has a prepayment penalty, and you want to pay your loan off early, talk to your lender. You may be offered an opportunity to pay off your loan closer to the final due date and sidestep the penalty. Or you might find that even if you pay off the loan early and incur a penalty, it might be less than the interest you would have paid over the remaining term of the loan.

•   You can also take a look at your loan origination paperwork to see if it allows for a partial payoff without penalty. If it does, you might be able to prepay a portion of your loan each year, which allows you to get out of debt sooner without requiring you to pay a penalty fee.

For example, some mortgages allow payments of up to 25% of the purchase price once a year, without charging a prepayment penalty. This means that while you might not be able to pay off your full mortgage, you could pay up to 25% of the purchase price each year without triggering a penalty.

Some lenders shift their prepayment penalty terms over the life of your loan. This means that as you get closer to the end of your original loan term, you might face lower prepayment penalty fees or no fees at all. If that’s the case, it might make sense to wait a year or two until the prepayment penalties are less or no longer apply.

When it comes to your money, you don’t want to make any assumptions. You still need to do your due diligence by asking potential lenders if they have a prepayment penalty. The Truth in Lending Act (TILA) requires lenders to provide documentation of any loan fees they charge, including a prepayment penalty. Also, under the TILA, consumers have the right to cancel a loan agreement within three days of closing on the loan without the lender taking any adverse action against them.

The Takeaway

A prepayment penalty is one fee that can be avoided by asking questions of the lender and looking at the loan documents with a discerning eye. This may hold true both when you are shopping for a loan and when you are paying your loan off.

Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. Checking your rate takes just a minute.

SoFi’s Personal Loan was named NerdWallet’s 2024 winner for Best Personal Loan overall.

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SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .

Non affiliation: SoFi isn’t affiliated with any of the companies highlighted in this article.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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Personal loans can be either secured or unsecured. A secured personal loan has collateral that backs the borrower’s promise to repay the loan. An unsecured personal loan does not require collateral, and the only thing backing the borrower’s promise to repay is their creditworthiness.

The collateral requirement is the main difference between secured and unsecured personal loans, but there are other differences that may inform your decision about which type of loan is best for your financial needs.

What Is a Secured Personal Loan?

A secured personal loan is a loan for which the borrower pledges collateral that the lender can take possession of if the borrower fails to repay the loan. Put in simpler terms: If you default on your car loan, for example, the bank can repossess your car. For the lender, collateral equals a certain level of security.

Collateralized loans are common for mortgage and auto loans. A home is collateral for a mortgage, and a vehicle is collateral for an auto loan. They are somewhat less common for personal loans, though.

A personal loan isn’t tied to a particular asset in most cases, so there’s not an obvious item to pledge as collateral. The asset pledged must be owned by the applicant, and the lender will evaluate its value to be sure it’s equal to the amount of money being loaned. In some cases, a physical asset such as a vehicle is put up as collateral, but the collateral could also be an asset like a savings account or certificate of deposit.

Pros of Secured Personal Loans

While it may seem like the lender benefits more with a secured personal loan, there may also be advantages for the borrower.

•   Lenders typically see secured personal loans as less risky than their unsecured counterparts because there is an asset to back the loan if the borrower defaults.

•   Borrowers may get a lower interest rate on a secured personal loan than they might on an unsecured personal loan.

•   Secured personal loans can be a good way for borrowers to build credit, as long as they make regular, on-time payments.

Cons of Secured Personal Loans

Things that a borrower might see as a drawback to a secured personal loan might be a benefit to the lender. But each party to the loan agreement takes risks.

•   The lender is able to recoup its losses by seizing the collateral if the borrower defaults on their secured personal loan. However, it may take a while to liquidate that asset. If the collateral is a physical asset, such as a vehicle, it may take some time to find a buyer willing to pay the price the lender has set.

•   For the borrower, the main drawback to a secured personal loan is the possible loss of the asset pledged as collateral if they default on their loan.

•   The application and approval process may include more steps for a secured personal loan than an unsecured one because the asset’s worth will need to be valued.

💡 Quick Tip: Before choosing a personal loan, ask about the lender’s fees: origination, prepayment, late fees, etc. SoFi personal loans come with no-fee options, and no surprises.

What Is an Unsecured Personal Loan?

A personal loan that is backed mainly by the creditworthiness of the borrower is an unsecured personal loan. Sometimes called a signature loan, an unsecured loan does not require any collateral to guarantee the loan.

Defaulting on an unsecured personal loan can certainly have a negative effect on the borrower’s credit, but there wouldn’t be an asset to lose in addition.

Pros of Unsecured Personal Loans

Like their secured counterparts, unsecured personal loans can have benefits for both lender and borrower.

•   Lenders may be able to charge a higher interest rate on an unsecured personal loan because there isn’t any collateral to secure the loan. (This is a drawback for the borrower — see below.)

•   The borrower won’t lose an asset if they default on an unsecured personal loan.

•   The application process for an unsecured personal loan is generally much quicker than for one that’s secured because there is no asset to be valued.

•   Funds may be disbursed the same day or within a week, depending on the lender.

Cons of Unsecured Personal Loans

It may be relatively easy to find lenders who offer unsecured personal loans, but there are aspects that may be considered drawbacks.

•   Interest rates on unsecured personal loans may be higher than for secured personal loans because there is no asset backing the loan.

•   Some lenders may have minimum credit score requirements for approval of an unsecured loan, so applicants with poor credit may not qualify.

•   If the borrower defaults, their credit score may be negatively affected.

•   Applicants with lower credit scores may not qualify for loan amounts as high as those with higher credit scores.

Recommended: Personal Loan Calculator

Choosing Between Secured and Unsecured Personal Loan

There are lots of reasons for considering a personal loan in general, but choosing between a secured and an unsecured personal loan means taking some specifics into account.

Do You Have Collateral?

One of the main things to consider when thinking about applying for a secured personal loan vs. an unsecured personal loan is whether you have an asset of value that you’d be willing to risk.

If you do have such an asset, you may want to compare lenders who offer secured personal loans. Some online lenders offer secured loans, but they’re more commonly available through banks or credit unions.

Lenders may offer higher loan amounts for a loan backed by collateral than for one that isn’t, so if you need to borrow a large amount, it might be worth looking into a secured personal loan.

What Are You Planning to Use the Funds For?

Personal loan funds can generally be used for a wide variety of things, like debt consolidation, unexpected medical expenses, home improvement costs, and more.

If you need funds to pay multiple vendors or contractors — common in the case of wedding or home improvement costs — or you plan to consolidate other high-interest debt, an unsecured personal loan might be the right choice for you.

If you plan to purchase a specific item that might be considered an asset, however, the lender may want to attach that asset as collateral on the loan, thus making it a secured loan. Examples of this might be a secured personal loan to purchase land or to buy a boat.

What Type of Lender Is Right for the Loan You Need?

Another factor to consider when choosing between a secured or unsecured personal loan is the type of lender you’d rather work with.

Unsecured loans may be available through banks, credit unions, or online lenders. Not every financial institution offers unsecured loans, however.

Secured loans are more commonly offered by banks and credit unions — it’s less common to find one through an online lender.

If you have a savings account or certificate of deposit at your bank that you’d be willing to put up as collateral, it might be worth looking into a secured loan with your current bank.


💡 Quick Tip: Generally, the larger the personal loan, the bigger the risk for the lender — and the higher the interest rate. So one way to lower your interest rate is to try downsizing your loan amount.

Qualifying For a Personal Loan

There are different factors that go into qualification for a personal loan.

Each lender may have its own credit score, income, or debt-to-income ratio requirements, in addition to other factors. If you’re applying for a secured personal loan, each lender may have its own requirements for valuation of collateral.

It’s a good idea to compare lenders so you’ll have an idea of what they commonly require for an applicant to qualify for a personal loan. With that knowledge, you can better evaluate your own credit for the likelihood of being approved — or not.

Reviewing Your Credit Report

You can get a free copy of your credit report annually from each of the three major credit bureaus: Equifax™, Experian™, and TransUnion™. It’s a good idea to check all three because not all lenders report payment history to all three bureaus. The credit bureaus don’t share information with each other, so getting a complete picture of your credit may mean looking at all three reports.

Your credit report contains personal information about you and information about past and current credit accounts in your name.

Personal information includes:

•   Name, current as well as any other names you may have gone by in the past

•   Addresses, current and previous

•   Birthdate

•   Social Security number

•   Employer

Lenders typically report:

•   The total amount of the installment loan or line of credit

•   Your record of on-time payments

•   Any missed payments

If you’ve had any bankruptcies, foreclosures, or repossessions, they will likely be included on your credit report as well.

If there is missing, incomplete, or incorrect information on your credit report, you can file a dispute with the credit bureau. It’s a good idea to clear up any errors before you start applying for a loan so you don’t have any unexpected roadblocks on the way to qualification.

If, in the process of reviewing your credit report, you find that you don’t have much of a credit history or your credit isn’t up to qualification standards, you may decide to take some time to work on improving your credit situation. That could mean increasing your income, lowering your expenses, paying down or consolidating existing debt, or just learning how to better manage your overall finances.

Recommended: How to Get Approved for a Personal Loan


The Takeaway

There are situations where an unsecured personal loan might be the right financial tool for you, and there may be others that would be better suited to a secured personal loan. The main difference between the two types of loans is that one requires collateral — a secured personal loan — and the other doesn’t — an unsecured personal loan. Deciding between the two depends on the borrower’s willingness to risk the loss of collateral, as well as their overall creditworthiness.

Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. Checking your rate takes just a minute.

SoFi’s Personal Loan was named NerdWallet’s 2024 winner for Best Personal Loan overall.

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SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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Credit card churning describes when you open and then close a credit card to snag sign-up rewards. Given how much competition there is for your business as a card holder, there are many enticing offers out there of cash, points, miles, and more. Some people may be tempted to try to grab those freebies and bonuses, but this practice comes with pros and cons.

Read on to learn about credit card churning and whether it’s something you should ever try.

What is Credit Card Churning?

Credit card churning occurs when you open and close credit cards for the sole purpose of earning a sign-up bonus. The trick is to do it over and over again, with several credit cards. The end goal is to earn as many rewards as you can. In other words, maximizing your eligibility for points and prizes.


💡 Quick Tip: Some lenders can release funds as quickly as the same day your loan is approved. SoFi personal loans offer same-day funding for qualified borrowers.

Types of Sign-up Bonuses

Of course, there is no such thing as a free lunch or a free reward. Being rewarded usually costs you. In order to earn the credit card rewards, you are typically required to spend a certain amount of money on that credit card, and it has to be done within the first few months (in most cases, three months).

The way you’re lured into a sign-up bonus is by earning a large amount of rewards by spending only a small amount. This usually happens only with a new credit card as a “welcome” offer. If you are careful about what and where you spend, you may be able to save money and get rewarded in the meantime. However, as you’ll learn below, this practice can also have its downsides.

Can You Win at Credit Card Churning?

If you want to try to get rewarded via credit card churning, there are some important best practices to be aware of.

Pay Off Your Balance in Full Each Billing Period

This is a good tip even if you’re not gunning for reward points. If you don’t pay off your balance at the end of the month, the rewards you earn will wind up being a net loss as interest rates take their toll. There is no bigger credit card churning buzzkill than taking months or even years to pay off the debt you accumulate racking up charges to earn a sign-up bonus.

While on this subject, remember that paying off your credit card balance in full every month will keep away the interest charges that accrue when you don’t make a full monthly payoff.

Look at it this way: When it comes to credit card churning, it’s you against the credit card companies. You want to reap their rewards but not open yourself up to suffocating debt and high-interest charges.

Credit card churning can work if the consumer hits the rewards thresholds, but practice responsible spending. If you’re someone who doesn’t manage credit card debt well or tends to overspend just to cash in on the rewards, it might be better to steer clear of credit card churning.

Make Your Credit Card Payment on Time

Don’t be even a day late. Late fees can be a budget buster, and they can damage the credit rating you’ve worked so hard to keep strong. If other credit providers see a pattern of late payments, and they may not be so fast to offer you their credit card, which means no rewards, or give you their best rates.

An excellent way to avoid late payments is to schedule automatic payments through your debit card, or checking or savings accounts. This way, you just set it and forget it!

Have a Plan for Your Rewards

Enjoying the rewards you earn may mean so much more to you when you have a short-term goal for how to use them. Perhaps the points are for airline miles or a vacation destination. Maybe you can use them toward a new wardrobe or the latest electronics. Keeping your eyes on the prize will prevent you from squandering your reward points on something forgettable or regrettable. Stay strong.

Don’t Bite Off More Than You Can Chew

Fight the temptation to get greedy. New credit cards with amazing reward offers are a dime a dozen. They’re like buses: another one will come along soon.

Think about where you may be in a few short months if you take on too many credit cards and too much debt. That won’t be worth any amount of reward points. Only use the number of cards that you can tolerate without sinking yourself.

Focus on Credit Card Fees

Credit card companies tend to be selective about what they promote to you. The reward offer may come with annual fees, transfer fees, and other charges. If your card requires an annual fee, ask yourself if acquiring it is worth the reward points.

Shop Around

Be extremely selective in choosing your rewards-based credit cards. The competition among credit card companies for your business is intensely competitive. Take your time and wait for the best offer.

Be Wary of No-Interest Credit Cards

It certainly sounds tempting to get a credit card that charges zero interest, and as long as you plan to pay off your balance in full every month, you’re already ahead.

However, this type of offer for a balance transfer credit card can bite you on the back end with extremely high-interest rates when the period expires or a “transfer charge” when transferring your high-interest credit cards.

Charges like that could equal the same amount of money you would be paying in the interest you thought you were passing by. Be sure you’re aware of the pros and cons of no-interest cards.

Read the Fine Print

Always read the fine print. That amazing offer may have some exclusions and exceptions and other unpleasant surprises. The credit card company may be looking for a certain kind of cardholder, too; after all, they’re in business to make money. You may not be the customer the credit card company is looking for; you may have too many credit cards, to begin with, or have a credit rating that may not be acceptable.

Find out which of the reward rules are subject to change, and if there are any expiration dates or winning rewards. If you are not great at reading the fine print, find somebody who is, or call the credit card customer service line and get your answers.

Protect of Your Credit Score

A credit score is an overview of your credit history and payback behavior. Making timely monthly payments and not defaulting on any of your credit cards or loans, and you’ll be on the right path. It also helps to keep your debt utilization ratio (how much your balance is versus your credit limit) low; no more than 30% at most.

Always consider your credit score before you consider credit card churning. Recognize that if you apply for new credit cards, a hard credit inquiry will be conducted. This will temporarily lower your credit score a bit.

Be Organized

When it comes to credit card churning, always stay organized and aware. Know exactly what the offer is, and what you need to do to get it. Know the deadline for spending the money that will make you eligible for the rewards.

Keep up on your progress toward your rewards goal; how much more do you have to spend and how much more time do you have before the offer expires? Again, avoid the pitfall of impulse spending just to get your reward.

When to Avoid Credit Card Churning

Think of credit card churning possibly as a privilege you have to earn rather than a right that doesn’t require prior deliberation. If you fall into any of these following categories, think twice before opening another credit card.

The biggest takeaway here is if you have credit card debt, it doesn’t make sense to continue to rack up debt in the name of credit card churning. Instead, it’s best to make a plan to get out of credit card debt ASAP.

If Your Credit is Bad

Credit card rewards are meant for customers with good-to-excellent credit, not for customers with late payments or delinquent accounts. Think of this as an opportunity to work up your credit score. Once you do, you may be eligible for some offers.

If You’re About to Take on More Debt

Are you about to sign a mortgage or are on the verge of a car or school loan? Applying for extra credit cards for the sake of their rewards will more than likely affect your credit score, as noted above. Each hard credit inquiry will lower your score temporarily. The constant nature of credit card churning can possibly stand in the way of your loan request or result in you being offered a higher interest rate than you would be with a higher score.

If you’re thinking about credit card churning, wait until after you secure that all-important loan or at least wait until your loan is approved, your payments are underway, and your monthly budget adjusts to the debt increases.

If You Don’t Use a Credit Card That Often

Not over-using a credit card shows reserve, discipline, and smarts. However, your lack of credit card usage may not make sense for a credit card churn. In some cases, credit cards will only grant you rewards if you spend a certain amount of money, which means increasing your spending (and your debt). You might feel “obligated” to use plastic more than you would otherwise.

If You’re Already Earning Rewards on Your Credit Cards

Some credit cards offer travel points and other rewards, without you having to get into a spending contest.

If you are pretty disciplined about your monthly spending and careful about avoiding too much debt, you’ll probably already steadily earn points and rewards on the credit cards you have. Call customer service and ask what you are eligible for.

If This is Your First Credit Card

Usually, getting your first credit card is a chance to prove that you are responsible with credit. You can use that first card to spend wisely and prudently and pay your balance in full each month. This can build your credit score and keep your finances on the straight and narrow.

If you get involved with credit card churning right off the bat, it could lead to trouble that you don’t need when you’re first establishing credit. Fixing credit once it is broken takes a long time and can stand in the way of the things you may want and need to buy. Wait until you’re further along in the credit game, and when you’re earning money to handle a bit more debt.

If You Tend to Overspend

Know yourself. If you’re the type who tends to overdo it when using plastic and can’t resist BOGO sales and the like, proceed with caution. Getting a large number of credit cards can leave you open to running up a tab on many of them and accruing too much debt. In other words, if you are in the habit of overspending, think twice.

Too Much Credit Card Debt?

Credit card churning can be more harmful than it appears on the surface. It can lead to confusion, missteps, and more unmanageable debt. If you do find yourself with considerable credit card debt, you might look into a balance transfer credit card, debt counseling, or repaying the debt with a lower-interest personal loan.

Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. Checking your rate takes just a minute.

SoFi’s Personal Loan was named NerdWallet’s 2024 winner for Best Personal Loan overall.

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SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .

Non affiliation: SoFi isn’t affiliated with any of the companies highlighted in this article.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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There are two basic types of credit: installment and revolving. An installment loan is a form of installment credit that is closed-ended and is repaid in fixed payments over a regular repayment schedule.

Some common types of installment loans are mortgages, auto loans, student loans, and personal loans. If you’re considering borrowing money, you may be wondering what an installment loan is and how it works. We’ll provide some insight that may help.

What Is an Installment Loan?

An installment loan is a lump sum of money borrowed and paid back over time. Each payment is referred to as an installment, hence the term installment loan.

In contrast, revolving credit like credit cards can be borrowed, repaid, and borrowed again up to the approved credit limit.

Installment loans can be secured with collateral or they can be unsecured. Some loans may have fees and penalties. The interest rate may fluctuate, depending on whether you choose a fixed or variable rate loan.

Recommended: 11 Types of Personal Loans & Their Differences

What Is an Example of an Installment Loan?

Installment loans can have multiple uses. These include auto loans, personal loans, mortgages, and student loans.

Auto Loans

Borrowers can take out auto loans for new and used vehicles. Monthly installments average around 72 months, but shorter loans may be available.

Loans with longer terms tend to have higher interest rates. It may seem like you’re paying less because the monthly payments may be lower, but you could end up paying more over the life of the loan.

Mortgages

Mortgages, or home loans, typically have terms ranging from 10 to 30 years with installments paid back monthly. Depending on your mortgage, you’ll either pay a fixed interest rate — it won’t change throughout your loan — or variable, which can fluctuate after a certain period of time.

Personal Loans

Personal loans are more flexible types of loans in that borrowers can use them for most purposes — examples include home repairs or debt consolidation. Many personal loans are unsecured, and interest rates will depend on your credit history and other factors.


💡 Quick Tip: A low-interest personal loan from SoFi can help you consolidate your debts, lower your monthly payments, and get you out of debt sooner.

Student Loans

Student loans help borrowers pay for their post-secondary education such as undergraduate and graduate tuition costs. They’re either federal or private, and terms and rates will depend on a variety of factors.

Some student loans have a grace period, a period after graduation during which you aren’t required to make payments. Depending on how the loan is structured, interest may not accrue. Not all student loans have a grace period, however, so it’s important to verify your repayment schedule before you finalize the loan.

Pros and Cons of Installment Loans

An installment loan may or may not be the best fit for your borrowing needs. Consider the advantages and disadvantages, so you understand what you’re agreeing to.

Pros of Installment Loans	Cons of Installment Loans
Can cover small or large expenses	Interest charges on entire loan amount
Predictable payments	Can’t add to loan amount once it’s been finalized
Can refinance to lower rate	Can come with long repayment terms

Pros of Installment Loans

Expense

Most installment loans allow borrowers to take out large amounts, helping them to cover large expenses. For instance, many borrowers can’t afford to buy a house with cash, so mortgages can provide a path to homeownership.

Regular Repayments

Installment loans tend to come with predictable payment schedules. If you take out a fixed-rate loan, your payment amount should be the same each month. Having that knowledge of when and how much you need to pay can make it easier to budget.

Plus, installment loans have a payment end date. As long as you keep making on-time payments, your loan will be paid off in a certain amount of time.

Taking a careful look at your budget to make sure you can afford the monthly payments is an important consideration.

Refinancing

You may be able to refinance your loan to a lower rate if you’ve improved your credit or if interest rates go down. Refinancing may shorten your loan repayment schedule or lower your monthly payments.

There are typically fees associated with refinancing a loan, which is another thing to consider when thinking about this option.

Cons of Installment Loans

Not Open-ended

Once you finalize the loan and receive the proceeds, you can’t borrow more money without taking out another loan. Revolving credit like credit cards allow borrowers to use funds continually — borrowing and repaying up to their credit limit.

Commitment

When you take out a loan, being committed to paying it down is essential. Since some installment loans can come with longer terms — think mortgages — it’s important to make sure your budget can handle the regular payment.

Charged Interest

Like other types of loans, you’ll need to pay interest on installment loans. The interest rate you’re approved for is dependent on factors such as your credit history, credit score, and others. Applicants who have a deep credit history and a credit score at the higher end of the range will most likely qualify for the most competitive rates. If you’re stuck with a higher rate because of your less-than-stellar credit, you could be making larger payments and paying more in interest.

Aside from interest, you may have to pay fees to take out an installment loan. There may also be prepayment penalties if you want to pay off your loan early.

Installment Loans and Credit Scores

How you use an installment loan can affect your credit score. If a lender reports your activity related to the loan, it could affect your score in two ways:

•   Applying for a loan: A lender may want to check your credit report when you apply for a loan, which may trigger a hard credit inquiry. Doing so could temporarily lower your credit score.

•   Paying back a loan: Lenders generally report your activity to the three major credit bureaus. If you make regular, on-time payments, this positive mark on your credit report could raise your credit score. The opposite can happen if you’re behind on or miss payments.

Getting an Installment Loan

Since taking out an installment loan is a big financial commitment, you may want to consider the following best practices:

•   Shopping around: Getting quotes from multiple lenders is a good way to compare personal loans to find one that offers the best rates and terms for your financial profile.

•   Pre-qualifying for loans: Getting pre-qualified allows you to see what rates and terms you may qualify for without it affecting your credit score.^*

•   Enhancing your borrowing profile: Check your credit report for any errors or discrepancies. Making corrections could have a positive effect on your credit score.

•   Adding a cosigner: If you can’t qualify for an installment loan on the merits of your own credit, you may consider asking someone you trust and who has good credit to be a cosigner.

💡 Quick Tip: In a climate where interest rates are rising, you’re likely better off with a fixed interest rate than a variable rate, even though the variable rate is initially lower. On the flip side, if rates are falling, you may be better off with a variable interest rate.

Alternatives to Installment Loans

Here are a few alternatives to consider:

•   Using a credit card: If you don’t need a large sum of money or don’t know how much you’ll need to borrow, a credit card can be a smart choice. Paying the entire balance by the due date means you won’t have to pay interest. Paying at least the minimum amount due each month will keep you from incurring a late fee, but you’ll still pay interest on any outstanding balance.

•   Borrowing from your next paycheck: Some apps let you receive an advance on your next paycheck, if you meet qualifications. You agree to pay the advance back when your next paycheck is deposited into your bank account.

•   Borrowing from friends or family: Asking to borrow money can be an uncomfortable conversation to have. However, it may be an option if you can’t qualify for or would rather not take out a bank loan. Having a written agreement outlining each party’s expectations and responsibilities is a good way to minimize miscommunication and hurt feelings.

Recommended: Family Loans: Guide to Borrowing & Lending Money to Family

The Takeaway

If you’re looking for a loan, an installment loan might fit your needs. Shopping around for an installment loan is a good way to find the best rates and terms for your unique financial situation and needs.

Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. Checking your rate takes just a minute.

SoFi’s Personal Loan was named NerdWallet’s 2024 winner for Best Personal Loan overall.

FAQ

What is the meaning of installment loan?

An installment loan is a type of loan where borrowers take out a lump sum of money and pay it back in installments. Loan amounts can range from hundreds to thousands of dollars, and terms range from a few months to a few years.

What is an example of an installment loan?

Examples of installment loans include auto loans, personal loans, mortgages, and student loans.

Are installment loans bad for credit?

Making your scheduled monthly payments on time could improve your credit score. On the flip side, late or missed payments can hurt your credit score.

What is the difference between a personal loan and an installment loan?

Personal loans are types of installment loans. Other types include student loans, mortgages, and auto loans.

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The Consumer Price Index (CPI) is a monthly measure of how the aggregate costs of consumer goods and services in the United States are changing. Economists use CPI to help them understand whether the economy is in a period of inflation or deflation, and individuals can use it to get a sense of where prices might be headed.

What Is the Consumer Price Index (CPI)?

The CPI measures the change of the weighted-average prices paid by urban consumers for select goods and services, according to the Bureau of Labor Statistics (BLS). In other words, the metric tracks the rise and fall of prices over a given period of time.

Definition and Significance

As mentioned, “CPI” is short for Consumer Price Index, and it’s an often-cited economic indicator.

The BLS produces indexes that cover two populations: CPI-U covers all urban consumers, representing more than 90% of the population. And CPI-W represents urban wage earners and clerical workers, representing approximately 30% of the population. The CPI excludes people who live in rural areas, the military, and imprisoned people.


💡 Quick Tip: How do you decide if a certain trading platform or app is right for you? Ideally, the investment platform you choose offers the features that you need for your investment goals or strategy, e.g., an easy-to-use interface, data analysis, educational tools.

How the CPI Works

The CPI tracks prices for a basket of goods and services people commonly buy in eight major categories, including:

•   Food and beverage

•   Recreation

•   Apparel

•   Transportation

•   Housing

•   Medical care

•   Education and communication

•   Various services

CPI Formulas

Each month, the BLS contacts retailers, service providers, and rental spaces across the country gathering prices for about 80,000 items. It uses this data to calculate CPI using the following formula:

CPI = Cost of the Market Basket in a Given Year/Cost of the Market Basket in the Base Year.

The result is multiplied by 100 to express CPI as a percentage. The BLS uses the years 1982-1984 as its base year. It set the index level during this period at 100.

Annual CPI Calculation

Here’s an example of the annual CPI calculation, and comparing two different years to get a gist of the differences.

Imagine the cost of a hypothetical basket of goods in 1984.

	Sweatshirt	1 dozen eggs	Movie ticket
Price in 1984	$10	$1.50	$5
Quantity	2	6	10
Total Cost	$20	$9	$50

When you total the price of these goods you get $79. Using the CPI formula above you take $79/$79 x 100 = 100%. This is where the 1984 base rate of 100 comes from.

Now let’s consider the same basket of goods in 2023.

	Sweatshirt	1 dozen eggs	Movie ticket
Price in 2023	$24	$3	$15
Quantity	2	6	10
Total Cost	$48	$18	$150

When you total the prices of these goods you get $216. Now, when you plug this into the CPI formula you get $216/$79 x 100 = 273%. You can now tell that from 1984 to 2023 prices for this particular basket of goods have risen by 173%.

Diverse Categories Within CPI

The CPI tracks more than 200 categories of items, and within each category it samples hundreds of specific items at various businesses which serve to represent the thousands of items available to consumers. In addition to these categories, CPI includes government-charged user fees like water, sewages, tolls, and auto registration fees. It also factors in taxes associated with the price of goods such as sales tax and excise tax. However, it does not include Social Security taxes or income taxes that aren’t directly related to the purchasing of goods and services.

The CPI also does not include the purchase of investments, like stocks and bonds.

The Consumer Price Index (CPI) in Practice

The CPI can be used in a variety of ways, but perhaps most prominently, in economic policy.

Usage in Economic Policy

The CPI is the most common way to measure inflation, the economic trend of rising prices over time, or deflation, the trend of falling prices. The federal government — or the Federal Reserve, more specifically — sets a target inflation rate of 2% annually, and the CPI can help the government understand whether or not its monetary policy is effective in meeting this target.

Recommended: What Is Deflation and Why Does It Matter?

The Federal Reserve’s Utilization

The Federal Reserve may look at the CPI to gauge whether or not to raise interest rates, which may cool or heat up the economy, accordingly, by increasing the cost of borrowing. As borrowing costs go up, demand for goods or services tends to fall, lowering prices, and putting downward pressure on the CPI.

Implications for Other Government Agencies

Economists also use CPI as a measure of cost of living, the amount of money you need to cover basic expenses, such as housing, food, and health care. This is important because the government may make cost-of-living adjustments to programs such as Social Security benefits. As the cost of living rises, benefit amounts may be adjusted higher to keep up with the rising costs of goods.

Employers may also look at the cost of living to help them set competitive salaries and determine when to raise wages for employees.

Recommended: Cost of Living by State

CPI’s Influence on Market Sectors

The CPI can also have an influence on market sectors, like the housing markets, financial markets, and even labor markets. As noted, a lot of it is top-down — depending on how the Federal Reserve reads the CPI and decides to change interest rates, if at all.

Raising rates can temper demand in the housing market, as a mortgage can become more expensive. It can also slow down sales for all sorts of businesses, which is reflected in earnings reports and finally, in the stock market. That can then spill into the labor market, and potentially raise unemployment as companies look to cut costs.

All told, the CPI’s influence can run deep in an economy.

CPI Versus Other Economic Indicators

The CPI is only one of many economic indicators, as mentioned. Others include unemployment, and the Producer Price Index (PPI).

CPI vs Unemployment: Understanding the Relationship

As noted, there tends to be a relationship between the CPI and unemployment rate, as the Fed targets 2% inflation, and full employment. As such, it can decide to make changes to monetary policy to try and restore balance or at least get closer to its goals.

CPI vs PPI (Producer Price Index)

The Producer Price Index or PPI measures the average change over time in the selling prices received by domestic producers of goods and services. In simpler terms, this metric measures wholesale prices for the sectors of the economy that produce goods. Like the CPI, the PPI can help analysts estimate inflation, as higher prices will show up on the wholesale level first before they get passed on to consumers at the retail level.

Analyzing and Critiquing the CPI Methodology

The CPI is a useful measure in many ways, but it does have some limitations. First, it doesn’t apply to all populations in the United States. CPI considers urban populations alone, so it is not necessarily representative of the costs for those who live outside of those areas.

Also, the CPI calculation does not take into account all of the goods and services available to consumers or new technologies not yet considered consumer staples. What’s more, the metric does not provide any contact into what’s causing prices to move up and down, such as social or environmental trends.

CPI’s Broader Impact and Usage

CPI reports are issued monthly by the BLS, and are available to anyone who wants to access them online. They give a broad breakdown of the previous month, and compare price changes year-over-year, and month-over-month.

Breaking Down the Monthly CPI Report

The standard CPI report has an introduction that discusses the changes over the previous month, followed by a table that outlines changes in specific price categories over the past year and several months. It further breaks down food, energy, and “all items less food and energy,” providing additional insight for each category.

Anticipating the Next CPI Report

The BLS publishes the date and time of the upcoming CPI report on its website, typically the second week of the month, at 8:30am ET.

Contemporary Relevance of CPI

In recent years, many people have kept a closely-trained eye on the CPI and CPI reports due to increased costs following the pandemic in 2020. While there were a variety of reasons as to why prices increased, that bout of inflation — the first serious case of inflation since the 1980s — caught many people off guard, and strained consumers’ budgets.

It also led to the Fed increasing interest rates. Inflation, or the increase in the CPI over the past couple of years, peaked at more than 9% during the summer of 2022, and as of late 2023, was back down to around 3.1%.

Educational Resources and Further Reading on CPI

There are numerous resources and places to learn more about the CPI, especially after all the attention it has garnered in recent years.

Learning More About CPI

A simple internet search will net a cornucopia of results, loaded with information and insight into the CPI. You’re also likely to find opinion pieces and other media discussing the CPI’s shortcomings or strengths — it can be a good idea to consider everything, and formulate your own opinion.

But in terms of learning more about the CPI itself, the BLS publishes a handbook discussing the concepts and methods it uses, which can also be helpful if you’re hoping to bolster your CPI IQ.

CPI-Related Statistics and Where to Find Them

The BLS publishes the CPI, and a whole host of data and statistics related to it. With that in mind, it can be a great place to start when hunting down CPI-related data. There are multiple other sources that utilize the BLS’ data to compile charts, graphs, and more, but typically, it’s all sourced back to the BLS.

The Bottom Line: Why the CPI Matters to Everyone

Rising inflation decreases the value of individuals’ cash savings over time. Investing in stocks, bonds and other investments that offer inflation-beating returns may help consumers protect the value of their savings. Understanding CPI, and how it’s moving, can help you devise a strategy for your investment portfolio.

The CPI can be a deep topic, especially when you consider how it intersects and relates to other elements of the economy, such as unemployment and interest rates. And again, the more an investor understands about the underlying machinations of the economy, the more knowledge they’ll have to power their decisions in the market.

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