What is Installment Debt?
Installment debt refers to any loan that is repaid by the borrower in periodic (usually monthly) installments that include principal and interest.
How Does Installment Debt Work?
Installment debt, also called an installment loan, is granted to the borrower with a preset number of monthly payments of equal amount. These amounts are amortized to include a certain amount of principal and interest calculated over a set number of months. Once the borrower successfully submits all of these payments in their entirety, the loan is paid off.
To illustrate, suppose someone takes out a loan for $1000 at an interest rate of 10% (or 0.10) annually to be repaid in 12 monthly installments.
$1000 + ($1000*0.10) =
$1000 (principal) + $100 (interest) =
$1100 to be repaid in 12 installments
$1100/12 months = $91.66 per month
The borrower must pay 12 monthly installments of $91.66 each. This $91.66 comprises a portion of principal and a portion of interest. When the borrower pays the twelfth and final installment, he will have completely repaid the loan.
Why Does Installment Debt Matter?
When someone takes out a loan, his interest obligations accrue periodically at a specified rate. If left unpaid, the interest simply continues to accrue, requiring the borrower to repay more and more. An installment loan provides the borrower with a structured number of manageable, albeit mandatory, periodic installments. The structure of the loan also provides assurance to the lender that his or her loan will be repaid.
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