What is installment debt?

Installment debt is a loan typically taken out to purchase large purchases when you do not have the upfront cash you need to pay for them. The cash amount is delivered in one lump sum and then repaid in equal scheduled installments over a specified period of time.

Definition and Examples of Installment Debt

Installment debt is a loan typically taken out to purchase large purchases when you do not have the upfront cash you need to pay for them. The cash amount is delivered in one lump sum and then repaid in equal scheduled installments over a specified period of time.

Note: Fees and terms related to installment debt often depend on the lending entity. Payment terms can be weekly, bi-weekly, or monthly and can range from several months to several years. In most cases, repayments are made on a monthly basis, and the repayment period lasts for several years.

Debt is created whenever you borrow money. Debt is repaid until all scheduled payments are presented, hence the term “installment debt.”

This type of repayment plan is often used with mortgages, student loans, and auto loans, in particular.

How Does Installment Debt Work?

Installment debt is a popular financing method that allows you to purchase high-value items such as a home or car using borrowed funds instead of your own money.

Generally, when you borrow in installments, you receive the loan once in the form of a cash amount. After that, you are responsible for repaying the principal and interest (if any) of the loan in scheduled regular payments known as installments. Payments are calculated so that each one reduces the outstanding debt and ultimately brings your balance down to zero.

The terms of the installment loan are agreed upon between the borrower and the lender before accepting the offer. Therefore, it is important to review all details and ask any questions you need in advance.

Note: There are typically other fees associated with installment debt that borrowers must pay. This includes interest fees of course, as well as application fees, processing fees, and potential late fees. Because of this, you will usually pay back more money than you originally borrowed.

Installment debt payments are based on an amortization schedule, which outlines the amount of the monthly payment. Amortization schedules are created based on several factors, including: the total principal amount received, the interest rate applied, any down payments made, and the total number of payments.

For example, let’s take a look at a sample installment debt schedule. If you took out a loan for $30,000 at an annual interest rate of 10% to be repaid over six years, here’s how your schedule might look:

Beginning balance  Interest  Principal Ending balance Monthly payment 1 30,000  250  305.78 29,694.22 555.78   2 29,694.22  247.45  308.33 29,385.89 555.78 3 29,385.89 244.88 310.90 29,074.99 555.78 70 1,639.46 13.66 542.12 1,097.34 555.78 71 1,097.34 9.14 546.64 550.70 555.29 72 550.70 4.59 550.70 0

As this table shows, the largest amount of interest is paid at the beginning of the loan. The borrower then agrees to make 72 monthly installments of $555.78 each. By the 72nd payment, the borrower has fully repaid the principal amount borrowed of $30,000 and an additional amount of exactly $10,015.81 in interest. Once all 72 payments have been successfully made, the installment debt is considered fully paid.

Note:

Unlike a credit card account, installment debt cannot be reborrowed. Once the loan is paid off, the account is closed permanently. If you need an additional amount, the borrower must obtain a new loan.

Installment debt comes in two main types, either secured or unsecured.

Secured Debt

Secured installment debt is debt that uses collateral – an asset you own such as your home or car or even cash – to back the loan. If you are unable to repay the debt as agreed, the lender can seize the collateral and sell it to recover some or all of their money. Car loans and mortgages are typically repaid with secured debt.

For example, assume you are buying a car using borrowed funds. The lender can repossess the car and sell it if you are unable to pay the full amount of the loan.

Note: If the sale of the collateral does not yield enough funds to cover the total debt owed, you may still be responsible for repaying any remaining balance on the loan.

Unsecured Debt

Unsecured installment debt means debt that is not backed by any type of collateral. These loans are secured only by your promise to repay the money you borrow. Since these loans are considered riskier, lenders may charge higher interest rates to borrowers than for secured loans. Some examples of unsecured installment debt include personal loans or credit loans.

Types of Installment Debt

Installment debt comes in several different forms. Depending on the lender and the type of loan you choose, your interest rate, repayment terms, fees, and penalties will vary. Here is a brief description of each type:

Home Loan:

A home loan or mortgage is a secured loan borrowed to purchase a home, where the property serves as collateral. Installments are typically paid monthly over a period of up to 15 or 30 years.

Student Loans:

Student loans are unsecured loans that can come from government or private lenders, and typically do not require collateral. Unlike other types of installment debt, student loans typically have a grace period of six to nine months after leaving school before payments begin.

Car Loans:

Car loans are secured loans used to purchase a vehicle. The interest is usually at a fixed rate with installment payments ranging from two years to ten years. The car serves as collateral, and the lender can repossess it if you fail to repay the debt.

Personal Loans:

A personal loan is an unsecured loan that does not need to be used for a specific purchase. Borrowers can use it for almost any purpose, such as paying for a wedding, consolidating other debts, or making home improvements. Often, no collateral is required for these loans.

“Buy Now, Pay Later” Loans:

This is a payment option that allows you to pay in installments without interest on the purchase. Payments can be spread over several weeks or months, depending on the merchant and the purchase amount, and usually does not require collateral. Common examples of purchases using this method include electronics, furniture, and appliances.

Advantages and Disadvantages of Installment Debt

Advantages:

• Makes high-value purchases accessible to consumers.
• Most installment loans are granted in immediate cash amounts.
• The interest rate is usually fixed.
• Once the debt is paid off, the account is closed permanently.

Disadvantages:

• Interest and fees increase the amount you will repay more than what you borrowed.
• Some installment debts require collateral.
• The obligation does not end until the total amount is repaid.

Alternatives to Installment Debt

Alternatives to installment debt include lines of credit or revolving credit accounts. These types of accounts are open-ended, meaning you can borrow money up to a certain limit and repay it repeatedly as long as your account remains open and in good standing. Examples of these types of loans include credit card accounts or a home equity line of credit.

The disadvantage
In revolving debt, interest rates are not always fixed, and payments can vary, while the option to reuse funds makes it difficult to see your balance decrease.

Key Takeaways

Installment debt, or an installment loan, is a loan where a fixed amount of money is borrowed and then repaid in regular installments over a specified period of time. Installment debt comes in two main forms, either secured or unsecured, with secured debt requiring collateral for the loan. Installment debt is a good option for those looking to make a high-value purchase.
Source: https://www.thebalancemoney.com/what-is-installment-debt-5199482