What Are Installment Loans?

Reviewed: February 11, 2014
By FinanceWeb

Few individuals today have the ability to pay cash for everything they need. Whether they desire an engagement ring for that special night or a new car to get to work, people require a more affordable way to make purchases. Lenders have crafted ways to get men and women the money they want while still stretching out the debt schedule. Here are the ins and outs of those installment loans.

Paying in Installments

An installment loan involves a debt that must be paid back through two or more scheduled payments. The definition is intentionally vague because many financial accounts qualify. Installment loans can be unsecured signature loans, secured personal loans, auto loans and even mortgages. All of the following are examples:

– Roger’s brother gives him $600 and tells him to pay back $50 per paycheck.
– Vic finances a new television and spreads the cost over three equal payments.
– Maria requests a $5,000 debt consolidation loan at 12.9 percent interest from her credit union. She agrees to pay $168 monthly for three years.
– Benny finds an online lender who will front him $18,190 for a Honda Civic. After the car has been delivered, he must budget $335 a month on a five-year installment car loan.
– Sasha and Patil qualify for a fixed-rate mortgage from a national bank. After all of the closing costs have been paid, they owe $1,996 per month for 30 years.

Installment Loan Details

When a lender funds an installment loan, the company is issuing a one-time, lump sum of money. An installment loan is not a line of credit, like a credit card or a charge account. Once the money is gone, it cannot be tapped into again without a new application. Here are more details about what installment loans are and are not:

Loan total: Although most installment loans amount to only a few thousand dollars, the actual balance does not matter. It can reach into the hundreds of thousands or even millions.

Interest rate: Each lender sets the annual percentage rate for finance charges. While family loans may be interest-free, commercial lenders will specify a rate in their loan agreements.

Payment amount: Most installment loans combine principal and interest into flat payments for the life of the loan. The borrower may end up paying more toward interest at the beginning, as with a mortgage, but the out-of-pocket expense stays the same. Certain installment loans feature a balloon payment, which means that the final loan payment is substantially larger than the ones preceding it.

Repayment period: Some installment loans last for a couple of weeks or months while others drag on for years. The loan terms state the length of the contract and whether it can be ended early, with or without penalties.

Collateral requirement: As with any loan, the bank may require some form of security before approving the financing. This practice is especially common with bad credit loans. If the borrower stops making payments, the bank can repossess the security item, sell it and get some money out of the deal. With a mortgage, the house is the security or collateral. With an auto loan, the vehicle is the collateral. On the other hand, the bank may grant small personal loans without any physical means of recourse. The loans made without any collateral are called unsecured installment loans.

Paying in installments is a simple way to make purchases now and repay the borrowed funds over time. Consumers should always review the installment loan terms before accepting any money.