what is installment debt
Installment debt is a loan that is repaid by the borrower in regular installments. Installment debt is generally repaid in equal monthly payments that include interest and a portion of principal. This type of loan is an amortized loan which requires a standard amortization schedule to be created by the lender detailing payments throughout the loan’s duration.
BREAKING DOWN 'Installment Debt'
Installment debt is a favored method of consumer financing for big-ticket items such as homes, cars and appliances. Installment debt is also favored by lenders since it offers a steady cash flow to the issuer throughout the life of the loan with regular payments based on a standard amortization schedule.
The size of the monthly installment debt payments will be determined by the amortization schedule. The amortization schedule is created based on a number of variables, including the total principal issued, the interest rate charged, any down payment and the number of total payments.
For example, few can afford to pay off the price of a home in a single payment. Therefore a loan is issued with a principal amount that covers the home’s value and is amortized with monthly installment payments over a period of time. Mortgage loans are typically structured with a 15-year payment schedule or a 30-year payment schedule. Mortgage borrowers have the opportunity to make steady installment debt payments over the life of the loan which helps to make purchasing a home more affordable.
Conversely, an appliance that costs $1,500 can be paid off in a year by most people. The buyer can further reduce the monthly payments by making a substantial down payment of $500, for instance. In this case, assuming an interest rate of 8%, the equal monthly payments over one year would be approximately $87, which means the total financing cost over the one-year period is about $44. If the buyer does not have the resources for a down payment and finances the full $1,500 cost of the appliance for one year at 8%, the monthly payments would be $130.50. The total financing cost in this case is a little higher at $66. (The calculations here were done using the Equated Monthly Installment method.)
Traditional loans from financial institutions for homes and automobiles are a prominent source of lending business for lenders. The majority of these loans are based on conservative underwriting with standard amortization schedules that paydown principal and interest with each installment payment.
Alternative installment debt loans are also offered by a variety of higher risk alternative lenders in the credit market. Payday loans are one example. They charge higher rates of interest and base the principal offered on a borrower’s employer and per paycheck income. These types of loans are also paid with installments based on an amortization schedule however their underlying components involve much higher risks.
In 2014, the Dodd-Frank Act instituted legislation for qualified mortgages. This provided lending institutions with greater incentives to structure and issue higher quality mortgage loans. Standard installment repayment terms are one requirement for qualified mortgages. As a qualified mortgage a loan, it is eligible for certain protections and is also more appealing to underwriters in secondary market loan product structuring.
An installment loan is one of the most traditional loan products offered by lenders. Lenders can build a standard amortization schedule and receive monthly cash flow from both principal and interest payments on the loans. High quality loans can be accepted as qualified loans receiving certain protections and offering the opportunity for sale on the secondary market which increases a bank’s capital.
Installments loans can generally be much lower risk than other alternative loans which do not have installment payments. These loans can include balloon payment loans or interest only loans. These types of alternative loans are not structured with a traditional amortization schedule and are issued with much higher risk than standard installment loans.
wiseGEEK: What is an Installment Debt?
For business purposes, an installment is a periodic payment. Installment debt is a loan which requires payments at regular intervals, usually monthly, for a set time period. Installment loans can be used for both secured and unsecured debt.
Installment debt is a popular method of purchasing big ticket consumer goods. It could be difficult for many people to buy vehicles, appliances, and other large ticket items if they had to pay cash. For an expensive purchase, the buyer may be required to make an initial investment, called a down payment. This payment is often larger than the subsequent periodic obligations. The advantage of using installment financing is that the buyer is able to begin using the product immediately, instead of waiting until he can afford to make a cash purchase.
Another advantage of purchasing through installment debt is that a buyer can frequently obtain a lower interest rate than he would if buying with a credit card. Unlike credit cards, an installment payment stays the same, and the buyer has a definite date when the debt will be paid in full. Credit cards, on the other hand, lower the minimum monthly payment as the balance decreases and a debt can take years to retire. Also, credit card companies frequently increase interest rates if a payment is ever late. With an installment loan, there is no acceleration of interest.
There are also advantages to businesses utilizing installment debt to finance the purchase of their merchandise. The most obvious is an increase the number of potential buyers. Businesses that finance their own products also benefit from the interest collected. In addition, the seller maintains ownership in the property until the amount is paid in full. If the buyer stops making payments, or defaults, then the owner can repossess, or reclaim the property, and the buyer forfeits all payments.
Installment loans used to purchase personal property are called secured loans. There are some financial institutions, however, that are willing to make unsecured personal loans using an installment plan. The interest rates charged for this type of installment debt is usually higher, since the lender is at greater risk. If a borrower defaults on an unsecured loan, the lender has no property to repossess.
Once an installment debt has been paid, the lender is required to release his ownership claim in the property. For example, an automobile that is financed has the name of the lender on the title. Once the vehicle is paid for, the lender is required to provide a release to the borrower so that a new title can be issued. Who files the release, either borrower or lender, varies between jurisdictions.
Having an installment loan can also help an individual establish credit. One factor considered by credit reporting agencies when calculating credit scores is how many types of debt a consumer has utilized. If a person has made timely payments on both a credit card and installment debt, he will receive a higher score than if he his only obligations have been revolving credit.
While it is good to be cautious before entering into any loan agreement, an installment debt may be a good option. Handled properly, it is a way to acquire a large ticket item through budgeted payments. The lower interest rate and set term can be an attractive alternative to large credit card purchases.
Instalment debt is a specific amount of money borrowed for a specific purpose and repaid over a set period of time. Personal loans, car loans and leases, and mortgages are examples of instalment debt.
Term loans are repaid in regular payments over a set period of time. Most personal loans and car loans are term loans.
- Payments are applied to both interest and principal.
- The total amount of interest you will pay is determined at the time the money is borrowed.
- Interest may be a fixed rate for the entire term or a variable rate.
- The payments are the same amount, but over time the ratio of principal to interest that is being paid shifts. The amount that is being paid to interest gradually decreases as the principal is reduced.
- You can often choose the payment frequency – monthly, bi-weekly, weekly, etc.
- Most terms loans can be paid in full at any time.
- The financial institution may charge processing fees, application fees or other set-up costs.
When you lease a vehicle, the dealership estimates what the value of the vehicle will be at the end of the lease term, known as the residual or buyout amount. The residual amount is subtracted from the purchase price of the vehicle, and you finance the remaining amount.
- You don’t finance the full amount of the vehicle, but you don’t own the vehicle at the end of the lease period.
- The interest portion of the lease payment is based on the total purchase amount of the vehicle, not just the lease amount.
- At the end of your lease you may walk away from the vehicle or arrange to purchase it by paying the residual amount.
- Monthly payments for leases are generally lower than those for loans on the same vehicle.
- You will be responsible for mileage and excessive wear and tear.
- It’s often expensive to break a lease before the term is up.
Mortgages are loans generally used to purchase real property and the loan is secured by a lien on the property. Mortgages can also be placed on a property you already own as security for a loan for another purpose.
- Mortgages require a down payment of at least 5% of the purchase price of the home.
- The principal is amount of money being financed—the amount of the mortgage.
- Mortgages are amortized over many years, generally between 10 and 30 years. Shorter amortization periods save you money because you pay less interest over the life of the mortgage.
- While amortization is the length of the loan, the term is the time period where interest rates and payment amounts are set. There are usually several terms within the amortization period. Terms are usually between six months and five years, although some longer terms are available.
- At the end of the term you may pay out the mortgage or renew the mortgage for another term at the new interest rates.
- You can choose the payment frequency – monthly, bi-weekly, weekly, etc. More frequent payments help pay the principal down faster.
- Open mortgages allow you to pay some or the entire principal at any time without penalty. In exchange for this flexibility, the interest rates tend to be a little higher than closed mortgages.
- Closed mortgages have restrictions on the amount of principal you can pay in addition to you regular payments. The interest rates tend to be a little lower than open mortgages.
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Simply put, installment debt is nothing more than mortgaging your future income. Technically, it
is any debt that you must pay back by a certain time or schedule. I define it as debt that puts your future wealth and security “in-stall.” Your mortgage loan typically represents your largest installment debt and, of course, is secured by your home.
I’m amused when I hear advertising such as, “apply for a home loan and enjoy home ownership today.” What a crock! If you think you enjoy “home ownership” when you have a mortgage, try missing three consecutive payments and discover for yourself who actually owns your home. Rather, you’ll learn that you’re nothing more than a slave to a 30 year mortgage payment – one- third of a century – typically representing the best years of your life.
Again, I’m not suggesting that you never finance a home. You will probably need to, at least a short-term loan in order to buy your first home. I hope you understand that the Financially Fit for Life philosophy is based on common sense and is designed to help you get what you want in the shortest time possible. So let’s go on.
The way I see it, all installment loans are like “mini-mortgages” with their own nasty little personalities and high-pitched voices that always remember to call if you are late with a payment.
I imagine each installment loan as an individual monkey – a smelly monkey with red eyes, sharp scratchy nails, teeth that bite and fleas that make you their habitat. Revolving credit is even worse, since it seems to revolve forever.