What Is Installment Debt?

Definition and Examples of Installment Debt

Installment debt is a loan that is typically taken to make large purchases when you may not have the upfront cash you need to pay for it. The cash is a fixed amount you receive in one lump sum and then is repaid in equal scheduled payments (or installments) over a set period of time. 

Debt is created any time you borrow money. The debt is then owed until each scheduled payment is submitted, thus the term "installment debt."

This type of repayment plan is often used with mortgages, student loans, and auto loans, to name a few.

• Alternate names: Installment loan, installment credit, closed-end credit

How Does Installment Debt Work?

An installment debt is a popular financing method that allows you to purchase big-ticket items such as a home or car, using borrowed money instead of your own.

In general, when you take on installment debt, you immediately receive the loan in a one-time lump sum. After that, you become responsible for paying back the loan principal and interest (if applicable) in regularly scheduled intervals, known as installments. The payments are calculated so that each one reduces the debt owed and eventually brings your balance down to zero.

Terms of an installment loan are mutually agreed upon between the borrower and the lender before you accept the offer. Because of this, it is important to review all of the details and ask all of the questions you need ahead of time.

Installment debt payments are based on an amortization schedule, determining the dollar amount of each monthly payment. Amortization schedules are created based on several factors, which include: the total principal received, the interest rate being charged, any down payments applied, and the total number of payments.

To illustrate, let’s look at a sample installment debt schedule. If you take out a $30,000 loan with an annual interest rate of 10% to be repaid over the course of six years, here’s what your schedule may look like: 

As this schedule shows, the largest amount of interest is paid at the beginning of the loan. The borrower then agrees to pay 72 monthly installments of $555.78 each. By the 72nd payment, the borrower has paid the original $30,000 borrowed and an additional $10,015.81 strictly in interest. Once all 72 payments are successfully submitted, the installment debt is considered paid in full.

Installment debt comes in two major forms, either secured or unsecured.

Secured Debt

A secured installment debt is one that uses collateral—an asset that you own, such as your house, your car, or even cash—to ensure repayment of the loan. If you are unable to repay the debt as agreed, the lender can seize your collateral and sell it to recoup some or all of their money. Auto loans and mortgages tend to be paid with secured debt. 

For example, say you purchase a car using the money from installment debt. The lender can repossess the car and sell it if you cannot pay back the full amount of the loan. 

Unsecured Debt

Unsecured installment debt means a debt that is not supported by any type of collateral. These loans are secured solely by your promise to repay the money you borrow. Since these loans are considered riskier, lenders may charge borrowers higher interest rates than a secured loan. Some examples of unsecured installment debt include personal or signature loans and credit card accounts.

Types of Installment Debt

Installment debt comes in several different forms. Depending on the lender and loan type you choose, your interest rate, repayment terms, fees, and penalties will likely be different. Find brief descriptions of each below. 

• Home loan: A home loan or mortgage is a secured loan borrowed to buy a house, with the property acting as collateral. The installments are typically paid monthly over a 15- or 30-year term.
• Student loans: Student loans are unsecured loans that can come from either federal or private lenders, and usually do not require collateral. Unlike other installment debts, student loans typically have a grace period of six to nine months after leaving school before payments begin. 
• Auto loans: Auto loans are secured loans used for car buying. The interest is primarily a fixed rate with installment payments ranging between two and 10 years. The car acts as the collateral and can be repossessed by the lender if you are unable to pay off the debt.
• Personal loans: A personal loan is an unsecured loan that does not have to be used for a particular purchase. The borrower can use it for almost any purpose, like paying for a wedding, consolidating other debts, or making home improvements. Collateral for these loans is often not needed.
• Buy-now, pay-later loans: Buy now, pay later is a payment option that allows you to make installment payments without paying interest on your purchase. Payments can be spread out over a few weeks to several months, depending on the retailer and the purchase amount, and don’t typically require collateral. The most common purchases using this method include electronics, furniture, and appliances.

Pros and Cons of Installment Debt

Pros Explained

• Puts big-ticket purchases within reach for consumers: The main benefit of installment debt is that it allows consumers to make affordable scheduled payments for large purchases like buying a home or a vehicle. This way, long-term financial goals are in reach. 
• Most installment loans are given in immediate lump sums: With installment debt, you receive immediate access to a lump sum. This way, you can pay for the object at hand, like a car or a mortgage, right away while you pay the loan back. 
• Interest rates are typically fixed: With a fixed interest rate and a flat monthly payment that does not change, consumers know exactly what their debt repayment plan will look like. Plus, the payments are equally spread out over a specified length of time.
• Once the debt is paid off, the account is permanently closed: As funds are usually a one-time loan that cannot be reused, the debt is paid off and the account is closed. This helps consumers avoid constant spending.

Cons Explained

• Added interest and fees means you’ll pay back more money than borrowed: Most installment debt payments accrue interest, as shown in the example above. Plus, there are many fees often associated with installment loans. Because of this, you’ll generally pay back more money than initially borrowed.
• Some installment debts require collateral: If you have secured installment debt, it is required that you provide an asset as collateral when you borrow. Assets like homes and vehicles can be taken over by the lender if you are unable to repay the debt in full.
• Debt responsibility does not end until the total amount is repaid: The borrower must repay the entire loan amount over the set amount of time for the debt to be considered paid in full. If you think you won’t be able to pay a loan over a long period of time, installment debt may not be the right repayment option for you. 

Alternatives to Installment Debt

The alternatives to installment debt are lines of credit or revolving credit accounts. These types of accounts are open-ended, which means you can borrow money up to your maximum limit and pay it down repeatedly, as long as your account remains open and in good standing. Examples of these types of loans include credit card accounts or a home equity line of credit (HELOC). 

The downside to revolving debt is that interest rates are not always fixed, payments can vary, and the option to keep reusing the money makes it harder to see your balance go down