What it is:
How it works/Example:
An installment loan can also be referred to as installment debt.
An installment loan is granted to a borrower with a fixed number of monthly payments that are of equal amount. These amounts are amortized to include a certain amount of principal and interest calculated over a set number of months.
For example, let's assume you take out a loan for $1,000 at an interest rate of 10% (or 0.10) APY to be paid back 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
Based on the calculations, you would make 12 monthly payments of $91.66 each. This $91.66 comprises a portion of principal and a portion of interest.
After you make 12 complete and on-time payments of $91.66, your loan will be paid off and no more payments will be required.
Why it matters:
Installment loans are great for businesses and individuals who lack the cash to purchase a big ticket item or service. They are a convenient way to pay for buildings, houses, cars, or even college tuition in manageable, periodic installments. The structure of the loan also provides assurance to the lender that his or her loan will be repaid.
Upon taking an installment loan, a borrower's interest obligations accrue periodically at a specified rate. If left unpaid, the interest simply accrues, requiring the borrower to pay a higher total amount for the loan.
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