Installment loan

An installment loan is borrowed once and paid back on a schedule fixed the day it is signed. The amount, the rate and the term set a monthly payment that does not change, and each payment is split between the month's interest on what is still owed and a reduction of the balance itself. The payment is sized so that the balance reaches exactly zero with the last scheduled payment, which is what gives the loan an end date, and it is why a $20,000 car loan at 6.9% costs $395.08 a month for sixty months and not a dollar or a month more.

In a sentence

• "A $20,000 car loan at 6.9% is an installment loan: sixty payments of $395.08, and $3,705 of interest over its life."
• "The student loans are installment loans, so every statement shows the same payment and one month less to go."
• "A card balance can be carried for years; an installment loan has its last payment written into it."

How it works

1. The amount, the rate and the term are fixed at signing: the principal, the annual interest rate, and the number of monthly payments.
2. The payment is computed once from those three, with the amortization formula, so that the balance reaches zero with the final payment.
3. Each payment covers the month's interest first, the remaining balance times the monthly rate, and the rest reduces the principal.
4. Because the balance falls, so does the interest, and the principal share of the same payment grows every month. Early payments are mostly interest; late ones are mostly principal.
5. An extra payment goes entirely to principal, which shrinks every later interest charge and moves the end date closer, unless the loan carries a prepayment penalty.

Payment = principal × r ÷ (1 − (1 + r)^−n), where r is the annual rate ÷ 12 and n is the number of monthly payments

An example

A $20,000 car loan at 6.9%, the example's assumption, over 60 months. The payment is $395.08.

The first payment is $115.00 of interest, $20,000 times 6.9% divided by twelve, and $280.08 of principal; the last is $2.26 of interest and $392.92 of principal. The loan costs $23,704.90 in all, and for the same $4,740.96 paid, the fifth year retires $1,099 more principal than the first.

Why it matters

The schedule is what makes an installment loan plannable and what makes it rigid. The payment is the same in the first month and the last, so it belongs in the budget as a fixed expense, and the end date is known in advance. The rigidity is the other side: the payment is owed in full whether the month was good or bad, and the term chosen at signing decides the total interest as much as the rate does, because a longer term lowers the payment and raises the total cost. A seven-year loan on a car that is worth little by year five is an installment loan chosen by its payment alone. The term also sets how fast the balance falls, and every dollar of principal paid is a dollar of net worth kept.

Installment loan versus revolving credit

Revolving credit has a limit and no term; an installment loan has a term and no limit to draw against. A card balance can be borrowed against again as it is repaid and lasts as long as the payments allow, while an installment balance only falls, on its schedule, and cannot be re-borrowed without a new loan. The payments differ the same way: a card's minimum is a percentage of a moving balance, and an installment payment is a fixed amount computed once. The same $20,000 as a car loan is gone in sixty payments; as a revolving balance it lasts as long as the payments let it. See Revolving credit.

Common questions

Is an installment loan the same as a personal loan? A personal loan is one kind of installment loan, usually unsecured and for a few years. Mortgages, auto loans and student loans are installment loans as well; what they share is the fixed amount, the set term and the scheduled payment.

Is a credit card an installment loan? No. A card is revolving credit, with a limit, a minimum and no end date. Some cards offer to convert a purchase into a fixed number of monthly payments, and buy-now-pay-later plans do the same at checkout; those are small installment loans beside a revolving account.

Why does so little of the early payment go to principal? Because interest is charged on the balance, and the balance is largest at the start. On the $20,000 loan the first payment is $115.00 of interest and $280.08 of principal; by the last it is $2.26 and $392.92. A loan calculator's schedule shows the shift year by year.

What is a good term for an installment loan? The shortest one whose payment fits the budget. A longer term lowers the payment and raises the total interest, and a term longer than the useful life of what the loan bought leaves payments on something that is gone. On a car loan, that is usually the difference between four years and seven.

Go deeper

• The Loan calculator estimates the monthly payment on a car, personal or student loan, the total interest over its life, and how much sooner it ends if you pay a little extra each month.
• The Mortgage calculator does the same for a home, principal and interest plus property tax, insurance, HOA dues and PMI, with the total interest over the life of the loan.
• How paying off debt raises your net worth even when savings don't move follows the principal in every payment onto the other side of the ledger.

Where it shows up in Zypper

Zypper keeps the loan's balance and its payment in view. Loans connect alongside checking and cards, including mortgages and auto, student and personal loans, and contribute their balances to the liability side of net worth, charted over time, so the balance falling by the principal each month is a line rather than a set of statements; a loan that cannot be connected is a manual account whose balance you set to the remaining principal. The payment leaving checking is identified as a recurring group from the pattern of your transactions, with its frequency, its next expected payment and amount, and its history on the recurring page, and it counts in the budget in the month it is due. See Supported account types and Recurring transactions and bill tracking for the details, or get started with Zypper to watch the balance fall.