Installment loan is a broad, overall term that applies to the
overwhelming majority of personal and commercial loans extended to borrowers.
Installment loans include any type of loan that is pay back with regularly
scheduled payments, or installments.
Each payment on an installment debt consist of repayment
of a portion of the principal amount borrowed and also the payment of interest
on the debt. The main variables that define the amount of each regularly
scheduled loan payment include the amount of the loan, the interest rate
charged to the borrower, and the length, or term, of the loan.
The Basics of Installment Loans
Common instances of installment loans includes auto loans,
mortgage loans or personal loans. Other than mortgage loans, which are frequently
variable-rate loans where the interest rate changes during the term of the
loan, nearly all installment loans are fixed-rate loans, meaning that the
interest rate charged over the term of the loan is fixed at the time of
borrowing. And so, the regular payment amount, typically due monthly, stays the
same throughout the loan term, making it easy for the borrower to budget in
advance to make the required payments.
Installment loans may be either collateralized or
non-collateralized. Mortgage loans are collateralized with the house the loan
is being used to purchase, and the collateral for an auto loan is the
vehicle being purchased with the loan. Some installment loans, often referred
to as personal loans, are extended without collateral being required. Loans
extended without the requirement of collateral are made based on the borrower's
creditworthiness, usually demonstrated through a credit score, and the ability
to repay as shown by the borrower's income and/or assets. The interest rate
charged on a non-collateralized loan is usually higher than the rate that would
be charged on a comparable collateralized loan, reflecting the higher risk of
non-repayment that the creditor accepts.
The Process of Installment Loans
A borrower applies for an installment loan by filling out an
application with a lender, usually insist on the purpose of the loan, such as
the purchase of a car. The lender discusses with the borrower various options concerning
issues such as down payment, the term of the loan, the payment schedule and the
payment amounts. For instance, if an individual wants to borrow N400,000 to finance the purchase of a car,
the lender informs the borrower that making a higher down payment could get the
borrower a lower interest rate, or that the borrower could obtain lower monthly
payments by taking out a loan for a longer term. The lender also reviews the
borrower's solvency to determine what amount and with what loan terms the
lender is willing to prolong credit.
Borrowers generally have to pay other fees in addition to interest
charges, such as application processing fees, loan origination fees and
potential extra charges such as late payment fees. The borrower ordinarily
retires the loan by making the required payments. Borrowers can usually save
interest charges by paying off the loan before the end of the term set in the
loan agreement. However, some loans carry out prepayment penalties if
the borrower pays off the loan early.
Advantages and Disadvantages
Installment loans are flexible and can easily be tailored to the
borrower's specific needs in terms of the loan amount and the length of time
that best suits the borrower's ability to repay the loan. Installment loans let
the borrower obtain financing at a substantially lower interest rate than what
is usually available with rotating credit financing, such as credit
cards. This way, the borrower can keep more cash on hand to use for other
purposes, rather than making a large cash outlay.
For longer-term loans, the borrower might be making payments on a
fixed interest loan at a higher interest rate than the prevailing market rate.
The borrower may be able to refinance the loan at the prevailing lower interest
rate. The other main disadvantage of an installment loan stems from the
borrower being locked into a long-term financial obligation. At some point, circumstances
may render the borrower incapable of meeting the scheduled payments, risking
default and possible forfeiture of any collateral used to secure the loan.
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