How Does Installment Loan Work?

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An installment loan refers to a loan that is extended to personal as well as commercial loans that is extended to the borrowers. These loans entail any type of loan that is paid back with a consistent schedule or with installments. Each payment entails the repayment of a part of the principal amount borrowed and also includes interest as well. The primary variables that ascertain the amount of cash to be paid on the monthly basis include the principal, interest and the length and term of the loan.

Process

A borrower approaches the lender to apply for the installment loan by submitting a complete application that mentions the purpose of the loan like buying a house. The lender discusses various options available to the borrower like down payment, loan terms, payment schedule, and payment amounts.

For instance, if a person wants to borrow money for buying a car, the lender specifies that when the borrower makes a higher down payment, the interest rate may lower down or they would have to pay lower payments on a monthly basis when applying for loan for longer term. The lender also determines the creditworthiness of the borrower to ascertain the amount the borrower can afford to pay monthly and the loan terms the lender is willing in order to extend the credit.

Borrowers have to pay extra fees as well apart from the interest charges, like the application processing fees, loan origination fees and late payment fees, if any. The borrower retires the loan by making the necessary payments. He can also save on the interest charges by paying off the loan before the due date mentioned in the loan agreement. But, many loans also have some prepayment penalties if paying off the loan before due date.

Pros and cons

These loans are flexible and can be customized to specific needs of the borrower when it comes to the loan amount and the length of time that aligns the most with the borrower’s ability to pay back the loan. With installment loans, borrowers can get the money at lower interest rate rather than what is available with revolving loans like credit cards. In this way, they can have more cash in hand for other uses instead of creating a huge cash outlay.

If the loans are on a long term basis, the borrower may make payments on a fixed interest loan at high interest than the market rate. They may also be able to refinance it at lower rate. Another con is that the borrower is stuck in a long term financial obligation. There may come a time where the borrower may not be able to repay the loan back, risking default or forfeiture of collateral in order to secure the loan.