installment loan examples

installment loan examples

What Are Some Examples of Installment & Revolving Accounts?

Credit cards offer an example of a revolving account.

Installment and revolving accounts are two different types of accounts involving credit. Though similar, there are some important differences between the ways these accounts work and how they impact your financial life. By understanding the differences between these types of accounts and how the credit bureaus consider these debts, you can better manage you credit score and improve your ability to borrow at better rates.

When you open an installment account, you borrow a specific amount of money, then make set payments on the account. When you take out the loan, you know the amount of the payment and how many payments you'll need to make to pay off the account. As you make the payments, the balance of the account lowers. Common examples of installment accounts include mortgage loans, home equity loans and car loans. A student loan is also an example of an installment account.

A revolving account allows you to borrow an amount up to a specific limit. For example, if you have a credit card with a $5,000 limit, you can borrow any amount up to $5,000. The payment amount on a revolving account varies depending on how much you borrow. As with an installment account, the balance decreases as you make payments. However, unlike an installment account, you can choose to continue borrowing against the account as you make payments. In addition to credit cards, other examples of revolving accounts include home equity lines of credit and accounts with overdraft protection.

In addition to installment and revolving credit, the credit rating company Experian recognizes two other types of credit: charge cards and service credits. A charge card works like a standard credit card, except that you must pay off the account’s balance in full each month. A service credit exists when you make an agreement with a company to pay a bill monthly. A common example of a service credit is electrical service. The electric company charges you each month for the electricity that you use and requires you to pay the bill in full.

Having a mix of installment and revolving accounts can help you build your credit score. This will help you to obtain credit and receive credit on better terms, both of which can help you to grow your business. Though the amount of payments remaining on an installment loan is a factor that credit bureaus use when setting your credit score, a bigger factor is the amount of revolving credit you're using. By paying down your balances on revolving accounts, you can improve your credit score by lowering both your total debt as well as improving your percentage of available credit.

Jay Motes is a writer who sold his first article in 1998. Motes has written for numerous print and online publications including "The Dollar Stretcher" and "WV Sportsman." He holds a Bachelor of Arts with a double major in history and political science form Fairmont State College in Fairmont, W.V.

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    Англо-русский экономический словарь .

    Смотреть что такое "Installment loan" в других словарях:

    Installment loan — An installment loan is a loan that is repaid over time with a set number of regularly scheduled payments. The term of loan may be as little as a few months and as long as 30 years. A mortgage, for example may be considered a type of installment… … Wikipedia

    installment loan — noun A loan that is repaid over time with a set number of regularly scheduled payments. A mortgage, for example may be considered a type of installment loan … Wiktionary

    installment loan — noun a loan repaid with interest in equal periodic payments • Syn: ↑installment credit • Hypernyms: ↑consumer credit, ↑loan … Useful english dictionary

    loan — A lending. Delivery by one party to and receipt by another party of sum of money upon agreement, express or implied, to repay it with or without interest. Boerner v. Colwell Co., 21 Cal.Sd 37, 145 Cal.Rptr. 380, 384, 577 P.2d 200. Anything… … Black's law dictionary

    loan — A lending. Delivery by one party to and receipt by another party of sum of money upon agreement, express or implied, to repay it with or without interest. Boerner v. Colwell Co., 21 Cal.Sd 37, 145 Cal.Rptr. 380, 384, 577 P.2d 200. Anything… … Black's law dictionary

    installment sale — Commercial arrangement by which buyer makes initial down payment and signs a contract for payment of the balance in installments over a period of time. In accounting for such sales, the seller may either account for the profits on basis of each… … Black's law dictionary

    installment sale — Commercial arrangement by which buyer makes initial down payment and signs a contract for payment of the balance in installments over a period of time. In accounting for such sales, the seller may either account for the profits on basis of each… … Black's law dictionary

    installment credit — noun a loan repaid with interest in equal periodic payments • Syn: ↑installment loan • Hypernyms: ↑consumer credit, ↑loan … Useful english dictionary

    installment plan — Commercial sales arrangement by which goods are sold and buyer pays for them in periodic payments. See also installment contract installment credit installment loan installment sale … Black's law dictionary

    installment plan — Commercial sales arrangement by which goods are sold and buyer pays for them in periodic payments. See also installment contract installment credit installment loan installment sale … Black's law dictionary

    Effective interest rate in the context of loans

    4. Effective annual interest rate on installment loans

    An installment (amortized) loan is a loan that is periodically paid off in equal installments. Examples may include car loans, commercial loans, and mortgages.

    There are four methods used to calculate the effective annual interest rate on installment loans (refer to the table below).

    Illustration 2: Effective interest rates on installment loans

    • Most accurate method
    • Used by lenders
    • Complicated formulas
    • Simple formula
    • Overstated EAR
    • Higher quoted rate, more overstated EAR

    M is the number of payment periods per year

    C is the cost of credit (finance charges)

    P is the original proceeds

    N is the number of scheduled payments

    • Simple formula
    • More complicated than constant-ratio method but less complicated than actuarial method
    • Slightly understates effective annual interest rate

    EAR = 6 x M x C ч [3 x P x (N+1) + C x (N+1)]

    M is the number of payment periods per year

    C is the cost of credit (finance charges)

    P is the original proceeds

    N is the number of scheduled payments

    • More accurate than constant-ratio or direct-ratio methods
    • Effective annual interest rate is slightly overstated or understated depending on the nominal rate and the maturity of the loan

    EAR = M x C x (95 x N + 9) ч [12 x N x (N+1) x (4P+C)]

    M is the number of payment periods per year

    C is the cost of credit (finance charges)

    P is the original proceeds

    N is the number of scheduled payments

    If the amount of payment or time between payments varies from period to period (e.g., balloon payments), the constant-ratio, direct-ratio, and N-ratio methods cannot be used. If a lender charges a credit investigation, loan application, or life insurance fee, such a cost should be added to the cost of credit (finance charge).

    Let us look at a simple example to see how the effective annual interest rate is calculated on installment loans.

    Company ABC borrows $12,000 to be repaid in 12 months. The monthly installments are $1,116 each. The finance charge is $1,400. What is the approximate value of effective annual interest rate?

    Constant ratio method:

    Using the actuarial method, the effective annual interest rate is likely to be close to 21.04%.

    As we can see from this example, the constant-ratio method overstated the effective annual interest rate, while the direct-ratio method slightly understated the effective annual interest rate on the installment loan.

    There is another method used to approximate this rate on one-year installment loans to be paid in equal monthly installments. The effective interest rate is determined by dividing the interest by the average amount outstanding for the year. If the loan is discounted, the average loan balance equals the average of proceeds (i.e., principal less interest).

    Company ABC borrows $10,000 at a 10% interest rate to be paid in 12 monthly installments.

    In this example, the EAR could be approximated as follows:

    Average Loan Balance = $12,000 ч 2 = $6,000

    Effective Annual Interest Rate = $1,200 ч $6,000 = 0.20

    If this loan is discounted, the effective annual interest rate will be calculated as follows:

    Average Loan Balance: $10,800 ч 2 = $5,400

    Effective Annual Interest Rate = $1,200 ч $5,400 = 0.2222

    "Installment loan" is a broad, general term that applies to the overwhelming majority of both personal and commercial loans extended to borrowers. Installment loans include any type of loan that is repaid with regularly scheduled payments, or installments. Each payment on an installment debt includes repayment of a portion of the principal amount borrowed and also the payment of interest on the debt. The main variables that determine the amount of each regularly scheduled loan payment include the amount of the loan, the interest rate charged to the borrower, and the length, or term, of the loan.

    Common examples of installment loans are auto loans, mortgage loans or personal loans. Other than mortgage loans, which are often variable-rate loans where the interest rate changes during the term of the loan, nearly all installment loans are fixed-rate loans, meaning that the interest rate charged over the term of the loan is fixed at the time of borrowing. Therefore, the regular payment amount, typically due monthly, stays the same throughout the loan term, making it easy for the borrower to budget in advance to make the required payments.

    Installment loans may be either collateralized or non-collateralized. Mortgage loans are collateralized with the house the loan is being used to purchase, and the collateral for an auto loan is the vehicle being purchased with the loan. Some installment loans, often referred to as personal loans, are extended without collateral being required. Loans extended without the requirement of collateral are made based on the borrower's creditworthiness, usually demonstrated through a credit score, and the ability to repay as shown by the borrower's income and/or assets. The interest rate charged on a non-collateralized loan is usually higher than the rate that would be charged on a comparable collateralized loan, reflecting the higher risk of non-repayment that the creditor accepts.

    A borrower applies for an installment loan by filling out an application with a lender, usually specifying the purpose of the loan, such as the purchase of a car. The lender discusses with the borrower various options regarding issues such as down payment, the term of the loan, the payment schedule and the payment amounts. For example, if an individual wants to borrow $10,000 to finance the purchase of a car, the lender informs the borrower that making a higher down payment could get the borrower a lower interest rate, or that the borrower could obtain lower monthly payments by taking out a loan for a longer term. The lender also reviews the borrower's creditworthiness to determine what amount and with what loan terms the lender is willing to extend credit.

    Borrowers generally have to pay other fees in addition to interest charges, such as application processing fees, loan origination fees and potential extra charges such as late payment fees.

    The borrower ordinarily retires the loan by making the required payments. Borrowers can usually save interest charges by paying off the loan before the end of the term set in the loan agreement. However, some loans impose prepayment penalties if the borrower pays off the loan early.

    Installment loans are flexible and can easily be tailored to the borrower's specific needs in terms of the loan amount and the length of time that best matches the borrower's ability to repay the loan. Installment loans let the borrower obtain financing at a substantially lower interest rate than what is usually available with revolving credit financing, such as credit cards. This way, the borrower can keep more cash on hand to use for other purposes, rather than making a large cash outlay.

    For longer-term loans, the borrower might be making payments on a fixed-interest loan at a higher interest rate than the prevailing market rate. The borrower may be able to refinance the loan at the prevailing lower interest rate. The other main disadvantage of an installment loan stems from the borrower being locked into a long-term financial obligation. At some point, circumstances may render the borrower incapable of meeting the scheduled payments, risking default and possible forfeiture of any collateral used to secure the loan.

    How Does an Installment Loan Work?

    An installment loan is financing that you repay with regular installments over a period of time. Mortgages, auto loans, personal loans and some business loans are common examples of installment loans. The purpose of borrowing in this way is to spread out the costs of a large purchase while acquiring the item up front.

    • Fixed payment amount
    • Interest rate
    • Loan term

    The fixed payment is the amount you pay toward the loan on a regular basis, often monthly. With a mortgage, for instance, you pay off a 30-year fixed loan with set monthly payments that go toward principal, interest and, in some cases, taxes and insurance. Each payment reduces the amount you owe on the principal balance. Credit cards aren't installment loans because monthly payments aren't fixed.

    The interest rate on an installment loan impacts the fixed payments as well as the total financing costs over the life of the loan. The loan term is the length of the repayment period. Fifteen and 30 years are common repayment periods on mortgages. Auto loans and personal loans are typically for a much shorter length.

    A key feature of an installment loan is whether it is secured or unsecured. A secured installment loan such as a mortgage, auto or boat loan requires that you put up property as collateral to get financing or a more reasonable interest rate. The primary concern is that the creditor may repossess your property if you fail to repay.

    Unsecured loans don't carry that risk, though you can take a serious credit score hit if you default. Personal loans are often unsecured. To get a favorable rate on an unsecured personal loan, you need excellent credit. Your proven reliability in paying off debt plays a big part in whether you are approved for the loan.

    Primary financial advantages of an installment loan relative to revolving credit include:

    • Predictable monthly payments
    • Early repayment options
    • Low rate and tax deduction opportunities
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