Installment Debt

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.

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 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 several variables, including the total principal issued, the interest rate charged, any down payment, and the total number of 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 covering 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. As a result, mortgage borrowers can 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.

On the other hand, if the buyer does not have the resources for a down payment and finances the total $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.

Special Considerations

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. In addition, 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 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. Most 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 interest rates and base the principal offered on a borrower’s employer and per paycheck income. These 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 more significant incentives to structure and issue higher-quality mortgage loans. Standard installment repayment terms are one requirement for qualified mortgages. In addition, as a qualified mortgage loan, it is eligible for certain protections and is also more appealing to underwriters in secondary market loan product structuring.

Installment Debt vs. Personal Loans

An installment loan is a financial vehicle in which a lender agrees to be paid back in installments versus one payment. For example, a mortgage payment is a type of installment loan repaid by the borrower in monthly installments that include principal and interest. Federal loans for education and mortgages are two types of common installment loans. An installment debt is money owed on an installment loan.

An installment loan is a type of personal loan, but there are other kinds of personal loans, including payments repaid in full with interest rather than in installments. A personal loan can come from a bank, a credit union, a boss, or a member of your family.

Advantages and Disadvantages of Installment Debt

Like any loan, there are advantages and disadvantages to taking on installment debt. For example, if you want to buy a house, an installment loan is a great way to borrow a large sum of money and pay it back over time. On the other hand, if you hate the idea of being in long-term debt, borrowing and then paying a personal loan off in full may be more appealing.

An installment debt is paid off on a regular schedule set by the lender. An installment loan allows you to budget your money each month while you are paying off your debt.

In some cases, when you have signed up to pay your loan off using installment payments, you will be charged with a penalty fee if you decide to pay it off early. In addition, installment loans take time to pay off, making them a financial commitment.

The Bottom Line

An installment debt is a type of loan repaid by the borrower in regular, often monthly payments that include the interest owed plus a portion of the principal.

An installment debt is an amortized loan and has a standard amortization schedule created by the lender that shows the borrower how much they will owe over the life of the loan. Mortgages and student loans are often forms of installment debt and allow borrowers to gain access to large sums of money. An installment debt is less risky than borrow large amounts that must be paid off in full with interest in a short amount of time.

Installment Debt FAQs

What Is an IRS Installment Agreement?

An IRS installment agreement is a plan used to pay the IRS via installments any tax you owe them.

How Much Interest Does the IRS Charge on Installment Agreements?

The IRS issues a charge of one-half of a 1 % rate on unpaid taxes up to 10 days. Afterward, the interest rises to 1%, but "if you file your return by its due date and request an installment agreement, the one-half of 1% rate decreases to one-quarter of 1% for any month in which an installment agreement is in effect," according to its website.

What Is an Installment Sale?

An installment sale is a sale of property where you receive at least one payment beyond the tax year of the sale. However, installment sale rules don't apply if you sell your property at a loss.

What Happens if You Don't Pay Your Installment Loan?

Like any loan, if you don't pay back what you owe, you can find yourself in a lot of financial trouble. If you default on your mortgage, for example, you can lose your home. In addition, if you don't pay your installment loan, the fees, interest, and potential penalty charges will increase. By not paying your loans, you risk damaging your credit, as well.

How Can You Get an Installment Loan With Bad Credit?

It is possible to get an installment loan with bad credit but you find yourself saddled with a higher interest rate on the loan if your credit is below 600. If you shop around for a loan, you may find one, even if your credit is considered "bad" by one of the "big three" credit bureaus. However, you may not qualify for a mortgage, which is a type of installment loan, with a score lower than 550.