How Do Installment Loans Work? The Only Guide You Need to Read

Until you get a loan, it’s difficult to understand how one works.

That’s the problem with loans. But, the truth is, most loans are easy to understand, including installment loans.

Installment loans are among the most popular type of loans you can get, but do you know what an installment loan is? Are you wondering how do installment loans work?

If these are the questions you have, you’re in the right place. Here is a guide to help you understand what installment loans are, how they work, and why people choose them.

The Basic Features of an Installment Loan

For a line of credit to qualify as an installment loan, it must have several basic features. You can define an installment loan through the following primary characteristics:

Principal Amount of Money

The principal amount of money refers to the loan amount. Suppose you borrow $5,000, your principal amount is $5,000. This amount shows how much you owe on the note.

If you put money down on the purchase, you would borrow less. In this case, your principal balance would be less than the purchase price.

For example, if you buy a car for $10,000 and put $1,000 down, your loan amount would equal $9,000. Your principal balance is $9,000.

Interest Rate

The second feature of an installment loan is the interest rate. These lines of credit have stated rates of interest.

You will know the percentage when you borrow the money, and this rate affects the amount of money you pay in interest for the lifetime of the loan.

Equal Payments

Another quality of an installment loan is equal payments. Every payment you make will be the same amount per month. You will know the payment amount when you borrow the money.

Set Duration

Finally, an installment loan always has a set duration. The duration is typically stated in terms of months. You may have a 12-month loan, which means you must make 12 payments, or it could be a different duration.

A common duration for car loans is 72 payments, which is a six-year car loan. For a mortgage, people generally choose 15-year or 30-year loans. The length is equal to 180 or 360 equal payments.

When you initially take the line of credit, you owe the full amount of money. When you make the last payment, you owe nothing. Your final payment pays the loan off in full.

The Types of Installment Loans You Can Get

Installment loans are popular for many reasons. The main reason people turn to these loans is to have time to pay for something.

For example, consider a car purchase. If you want to buy a $15,000 car, could you come up with $15,000 to pay for it upfront? Probably not, but you could turn to an installment loan.

When you take an installment loan to buy a car, you get the car now in exchange for agreeing to make payments for the next few years. Each month you pay your car payment until you make the last payment.

At that point, you’ll own the car and will no longer have a loan on it.

People use these lines of credit for all kinds of major purchases, including vehicles, homes, RVs, motorcycles, and jewelry. You can take an installment loan out for just about anything you want to buy.

How Do Installment Loans Work?

One unique aspect of an installment loan is the way interest and principal work. At the beginning of your loan, you owe the full amount.

Each time you make a payment, the lender divides the amount you pay between the principal and interest. At first, your payments will pay primarily interest and very little principal, but this equation changes over time.

By the time you make the last payment, the amount you pay will be applied for almost all principal and very little interest.

You build equity in your asset as you make your payments on the loan. At some point during the loan process, you could pay off your principal balance if you have the cash to do so. If you can do this, you could pay off the loan in full.

When you take an installment loan, the lender may give you a document called an amortization schedule. This schedule shows you how the lender will divide the payments between interest and principal.

The Application Process

If you would like to make a big purchase and need a loan to do so, you could apply for an installment loan. You can apply for one with any lender that offers the loan type you need.

If you need a vehicle loan, talk to an auto lender. If you want to buy a house, speak to a mortgage lender.

You can also borrow money through an installment loan for other purposes, other than buying an asset. For example, do you want to consolidate your debts or acquire cash to remodel your home?

You can apply for a personal loan for these purposes, and a personal loan is one form of an installment loan. If you’re interested in a personal loan, check out American Web loan reviews.

Depending on the reason for the loan, the lender you talk to may have credit requirements. You may need a specific credit score to qualify. You may also need to put some money down before the lender issues the line of credit to you.

Where to Turn When You Need to Borrow Money

Does this information answer your question, “how do installment loans work?”

If you’re interested in learning even more about these and other types of loans, check out our blog. We have a lot of informative and helpful articles on this topic as well as other financial-related issues.

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