Installment Loan

Installment loan summary: 

• An installment loan is a closed-end commitment that lets you make payments at regular intervals and usually for the same amount. 

• Installment loan balances decrease in a predictable way as you pay off the debt. 

• Some types of installment loans, like home mortgages or auto loans, are secured by collateral. Something valuable serves as a guarantee that you’ll repay the loan.

Installment Loan Definition and Meaning

An installment loan is a type of debt that is repaid with regular, ongoing payments, or installments. Installment loan payments are typically fixed (the same amount every time), and the payment schedule is often monthly. Examples of installment loans include mortgages, home equity loans, auto loans, student loans, and personal loans. 

Credit card debt is different from an installment loan. Unlike installment loans, credit card balances can increase or decrease based on your monthly spending and payments. And credit card payment amounts could be different every month, based on your outstanding balance and how much you choose to pay. 

Key Features of an Installment Loan 

Different types of installment loans have specific details, amounts, interest costs, and fees. But here are a few installment loan features you should understand. 

Lump sum

With an installment loan, you typically borrow a lump sum (a single, one-time amount of money) all at once. When applying for the installment loan, you decide how much money you want to apply for, and apply with a bank or other lender to loan you that amount. 

Closed-end loan

An installment loan is a limited commitment. It’s not open-ended; the bank or lender agrees to lend you money, but only for a specific amount and length of time. With a closed-end loan, the amount you can borrow doesn’t change. This feature of an installment loan is different from credit card debts, which are open-ended, meaning you could borrow, repay, and borrow more repeatedly. 

Loan term

An installment loan is for a certain amount of time, or term. For example, many home mortgages are for 30-year terms. Many auto loans have terms of three years to seven years. 

When you borrow money with an installment loan, you can often work with the lender to choose a loan term. If you choose a longer loan term, your payments are smaller, but the total amount of interest that you pay on the loan is likely higher. 

Interest

Installment loans generally charge you interest. The exact interest rate or annual percentage rate (APR) is based on your credit score, the loan amount, the loan term, and other factors. 

Collateral

Some installment loans require collateral. Collateral is something valuable that guarantees the loan. It’s a safety net for the lender. If you don’t repay the loan, the lender has the right to keep your collateral and sell it to recover the money you owe. 

The collateral for a mortgage is the home. The collateral for an auto loan is the car.  

Fixed payments

Usually, installment loan payments are the same amount every time. This makes installment loans more predictable than credit card debt, and perhaps easier to fit into your monthly budget. 

Your loan payment will be an amount that’s calculated to fully repay the loan by the end of your loan term.

Amortization

Most installment loans are amortized loans. This means that the amount of interest you pay with each loan payment gradually gets smaller.

At the beginning of a loan, a greater share of your payment goes to interest charges, and less goes to your principal balance. As you pay off the installment loan, the share of your payment that goes to interest gets smaller, and the amount that goes to the principal balance gets bigger.