An installment loan is one in which a person borrows a lump sum of money for a certain period, divided into several equal payments, also known as installments. Lenders usually charge interest on installment loans.
There are several types of installment loans. Some of the most common are car loans and mortgages. In both cases, a person borrows a specific amount of money, for example, the purchase price of a car. The loan is then set for a specific term, usually 60 or 72 months for most new vehicle loans or 15 or 30 years for most mortgages. These loans charge an interest rate that is factored into the loan payment, so the same number of payments will pay off both the loan and the interest on the loan. Interest is built into the payments, so both the loan and the interest are paid off simultaneously. This is known as an amortized loan.
Another common type of installment loan is a student loan. Although these loans are sometimes structured differently, while the borrower is an active student, after completing the educational program, the student loan becomes an installment loan with a set number of payments over some time.
Use of installment loans
Installment loans are often used to purchase more expensive items that may cost more than the borrower can afford to pay for in one payment, such as a hot tub, appliance, or boat. Personal loans are another common type of installment loan. However, unlike other installment loans, with a personal loan, the lender does not require that the funds be used to purchase a specific item. Instead, the borrower receives cash that they can use as they wish. As with installment loans, personal loans also have a set repayment schedule. If the loan is interest-bearing, the borrower pays back more than the original amount of the loan.
What types of loans are not installment loans?
Credit cards are not installment loans. Lines of credit, including personal lines of credit and home equity lines of credit, are not installment loans. With these types of loans, the borrower can borrow part or all of a predetermined amount of money. Although payments are usually similar to installment loans, a borrower with a line of credit can borrow more money than they started with, causing the payment amount to change. A person can even re-borrow money that was previously repaid. In any case, the amount of the loan is not fixed, and therefore neither are the payments.
The amount of interest paid is a function of the interest rate and the length of the loan. A higher interest rate will result in a larger amount needed to repay the loan. A longer-term will also result in a higher amount needed to repay the loan. A longer repayment term on an installment loan may reduce the amount of each payment, but it will increase the total amount paid from the same loan amount because there will be more payments.