An installment loan is one loan type that you can get, and many people get these when buying homes or cars. However, you can also get them for other reasons. The main premise of an installment loan is that you borrow money with the ability to repay the money over time. If you have never borrowed money through one before, you might wonder how they work. Here is an explanation of how installment loans work.
The Amount You Borrow Is the Principal
The first thing to understand is that the principal balance of the loan is the amount you borrow. The principal balance might be slightly higher than the amount you borrow, though, as it may include the fees for your loan. It might also be lower, though.
For example, if you take a $5,000 loan that has $500 in fees, your principal balance might be $5,500. If you put $1,000 down on the loan, your principal balance might be only $4,500.
The Lender Determines a Payment Amount
The lender uses the principal balance and the loan duration to determine your payment amount. They divide the principal balance by the number of months you want for the loan, and they add the interest. You will have a set payment amount to make every month, and this amount reflects the smallest amount you can pay monthly. You are always free to pay a higher amount, though.
The Payments You Make Go for Principal and Interest
Each time you make a payment, the lender applies part of the payment to interest and the other part to the principal balance. Therefore, the payment amount you make will not decrease the principal balance by the full payment amount. Instead, it will decrease it only a portion, as you must also pay for the interest.
You Make the Payments Until You Repay All the Money
You can make the payments as scheduled to repay your loan in full by the end date. If you want to repay it faster, you can pay extra money with each payment. Once you pay the entire principal balance, you will satisfy the loan.
Once you make the last payment, you satisfy the loan. If you would like to apply for an installment loan to buy a car, house, or anything else, find a lender that offers them. You can even borrow money through an installment loan to consolidate your debts or pay for bills that you cannot afford to pay for right now.