What is an Installment Loan and How Exactly Do They Work?

When you need to make a large purchase, such as a house or a car, you often take out an installment loan to do it. Student loans also are installment loans, as are personal loans. Here is a rundown of what an installment loan is and how it works.

Specific Amount

One of the hallmarks of an installment loan is that you borrow a specific amount one time. This can be $200,000 for a house, $20,000 for a car or $2,000 for personal use. 

Installment loan amounts can vary greatly, but they all have one thing in common: Once you have agreed on an amount and signed the papers with your lender, the amount is set, and the only way to change it is to take out a new loan.

Set Payment Schedule

Perhaps the thing that defines installment loans more than any other factor is the set payment schedule. With an installment loan, you pay a set amount each month for a predetermined amount of time. 

If you have a mortgage, your term is often 15 or 30 years. With a car loan, it might be five years. Personal loans may be only one or two years. 

Secured VS Unsecured

Installment loans can be either secured or unsecured. A secured loan is a loan in which the asset for which the loan was issued acts as collateral, meaning it can be foreclosed on and repossessed if you don't make the payments. 

Home and car loans are examples of secured installment loans. An unsecured loan is a loan with no collateral backing it, meaning the only recourse the lender has for nonpayment of the loan is to sue the borrower. 

Some companies, like Las Vegas Finance, know that personal loans and student loans are examples of unsecured installment loans.

Amortization

Most installment loans are amortized, meaning that while you make the same payment every month, the portion of the payment going to principal and interest changes. 

With most installment loans, most of your early payments go toward paying the interest on the loan and very little goes toward the principal. In the latter stages of the loan, that ratio flips. 

If your installment loan allows you to make extra payments or pay off the loan in full early, you can save money on interest costs by doing so.

It's likely you will take out an installment loan at some point in your life. Knowing what they are and how they work will help you make better decisions regarding the loans.