What Makes a Loan an Installment Loan?

There is a lot of confusion among consumers about the different kinds of loans available through banks, credit unions, and financial service companies. For example, it is not uncommon for people to unequivocally claim that payday loans are not installment loans. That is not necessarily true. Some are, others are not.

An installment loan is a specific kind of loan that takes its name from the way it is repaid. The ‘installment’ designation has nothing to do with the lender, how the borrower intends to spend the money, or any other factor separate from repayment terms. As such, it is very possible for a payday loan to also be an installment loan. That may not be the norm, but it is still possible.

Installment Loans and Payment Terms

Every loan offer comes with payment terms. Included in the payment terms is the frequency of payments and how long the borrower has to completely repay the debt. An auto loan is a good example. One with a 5-year term gives the borrower 60 months to repay both principal and interest. Those payments are made on a monthly basis.

It is the monthly payments that make the auto loan an installment loan. Simply put, installment loans take the amount owed and split them into equal payments – or installments – rather than a single, lump-sum payment. Sometimes, the final payment to an installment loan is bigger than the earlier payments and this last payment is then known as a “balloon payment”. The frequency of payments can be anything lender and borrower agree to. Monthly installments are the norm.

With this definition in hand, it is clear to see that the following kinds of loans are installment loans:

  • Mortgages
  • Auto loans
  • Personal loans
  • Home-equity loans
  • Student loans
  • Retail loans (e.g., financing the purchase of new furniture on installments).

Perhaps the reason most people do not associate payday loans with installment loans is the relatively short repayment time that is the norm for the payday loan industry. But again, payday loans can be offered as installment loans.

 

Loan Terms for Payday Loans

The payday loan gets its name from the fact that the earliest forms of these loans were generally made with the understanding that they would be repaid on the borrower’s next payday. Yet payday loans have evolved over time. They are still short term by nature, but they do not necessarily have to be repaid with a single lump sum.

There are payday loan providers that allow consumers to repay via installments – perhaps two or three installments over a couple of months and sometimes with a balloon payment at the end. Like any other kind of installment loan, the terms can be just about anything the lender and borrower agree to (within reason).

Installment Loans and Interest Rates

A large difference between long-term installment loans and their short-term counterparts is the amount of interest charged. Banks and financial services companies make a good deal of profit on interest payments to achieve a certain  return in order for lending to be profitable.

How does this relate to interest rates?  A lender can collect more interest the longer the term goes. With installment loans, you are paying interest while the loan is outstanding.  If an installment loan lasts longer, you are paying interest for a longer period of time. Over time the interest can add up. Payday loans are short-term loans because they are often due by the next pay date; lenders have a short period of time to collect interest on such loans. As a result, their interest rates tend to be higher.

On the other hand, long term installment loans tend to have lower interest rates because the lender has more time to collect interest on the loan.  These loans tend to have collateral (like a house or car) tied to the loan.

At the end of the day, an installment loan is simply a loan with terms that allow the borrower to pay back the debt via periodic installment payments. An installment loan can be anything from an auto loan to in-store financing and a payday loan can sometimes by structured as an installment loan.