What Is an Installment Debt?
An installment debt is a loan that is repaid by the borrower in regular installments. An installment debt is generally repaid in equal monthly payments that include interest and a portion of the principal. This type of loan is an amortized loan that requires a standard amortization schedule to be created by the lender detailing payments throughout the loan’s duration.
- An installment debt is a loan that is repaid in regular installments, such as most mortgages and car loans.
- Installment loans are good for borrowers as it's a way to finance big-ticket items, while they provide lenders with regular payments.
- Installments loans are generally less risky than other alternative loans that do not have installment payments, such as balloon-payment loans or interest-only loans.
Understanding Installment Debt
An installment debt is a favored method of consumer financing for big-ticket items such as homes, cars, and appliances. Lenders also favor installment debt 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 amortization schedule will determine the size of the monthly installment debt payments. 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. 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.
Installments loans are often lower risk loans than loans without installment payments.
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 that 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 a much higher risk than standard installment loans.
Types of Installment Debt
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 pay down 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.