Installment credit refers to a loan of a certain amount that the borrower gradually repays by making regular payments. Usually, the borrower gets the whole amount of the loan at the beginning of the loan period, then he or she pays back the amount over a fixed period of time. The repayments cover the principal amount and the interest of the loan.
In most cases, this type of credit usually involves a certain sum of money used to pay for a specific item, which is usually expensive. People take out a loan for installment credit when they obtain a home mortgage, automobile loan, home improvement loan, and student loan. Installment credits that usually involve smaller amounts of money include personal loans and vacation loans.
At the beginning of the installment credit, the lender provides the borrower with the whole amount of money he or she needs. The lender and the borrower agree on the duration of the loan, within which the borrower has to fully repay the principal amount and the interest of the loan. The interest rate could be fixed or variable; a fixed interest rate means that the borrower pays a certain amount every repayment period, while a variable interest rate could lead to fluctuating repayment amounts. The lender could require collateral that the lender acquires in case the borrower fails to make his or her repayments, such as the house in the case of a mortgage or the car in the case of an automobile loan.
For example, Jane needs $15,000 US Dollars (USD) to purchase a car, so she obtains an installment credit from a bank. Jane receives $15,000 USD to buy the car at the beginning of the automobile loan. The bank requires her to repay the money within 36 months and charges a fixed interest of 7 percent of the price of the car. Jane has to pay $463.16 USD to the bank every month to repay the loan. If Jane fails to make a minimum number of payments, the bank could repossess the car and sell it to repay the money it lent to Jane.
An installment credit usually has the borrower paying more in interest in the early stages of the loan. As the borrower makes more repayments and the amount of outstanding principal decreases, less of the repayment amount goes into paying the interest and more goes into paying the principal. This process is known as amortization.