Installment Debt

What is an 'Installment Debt'

An 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. It is a favored method of consumer financing for big-ticket items such as cars and appliances. The arrangement benefits all parties. The consumer benefits from financing expensive items at interest rates that are typically far lower than credit card interest rates. The dealer or seller gains through increased sales volumes, while the lender benefits by charging higher rates on installment debt than can be charged on other loans.

BREAKING DOWN 'Installment Debt'

The size of the monthly installment debt payments depends on a number of variables, including the price of the item, interest rate charged, down payment, loan term and debt-servicing capacity of the buyer.

For example, few can afford to pay off the price of a new car in a year or two, so these loans are typically structured with a repayment period that can range from three to seven years, with five years being the most common.

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.)

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