If you're paying off an installment loan or lending somebody money they can pay off in installments, you'll want to figure out the appropriate monthly installment payment so that the loan can be paid off in full at the end of the loan period. You can use a standard installment calculation to do so. If you have trouble paying off a loan on time, you can try to work with the lender to modify the loan terms or extend the payment period.
Understanding Monthly Installment Payments
Many loans that you take out are designed to last for a set amount of time. This includes mortgages used to buy real estate, auto loans used to buy cars and various types of consumer loans. These types of loans are sometimes known as installment loans and each payment that you make under the loan terms is known as an installment payment. Typically you will make a payment on the loan each month, and this payment is usually designed to be the same over the life of the loan to make repayment predictable.
If a loan didn't include interest, it would be simple to calculate the monthly payment plan for the loan. You could simply divide the amount borrowed by the number of months you have to pay off the loan and pay that fraction of the loan every month. While this might work fine for interest-free loans between friends or family, it's not viable for commercial loans, where lenders must charge interest to make money and offset their own risk.
For installment loans that charge interest, you must use a more complex formula to figure out the monthly installment payment based on the amount borrowed, the interest rate and the repayment period.
Credit cards and many lines of credit work differently from installment loans, because you're able to borrow more money up to a spending limit at any time. However, if you decide to stop spending money on a credit card and seek to pay it off over a given period of time, you can use the installment payment formula to decide how much to pay each month over that time period.
The Installment Loan Payment Formula
You can use a standardized formula to figure out the appropriate monthly installment period on an installment loan. This formula is:
P = r(V) / (1 - (1 + r)-n)
The formula may look a bit complicated, but it's easy to compute with a calculator if you have all of the data needed. The variable P represents the payment amount you're trying to compute. The variable r is the monthly interest rate on the loan, V is the initial principal amount borrowed and n is the number of months you have to pay off the loan. If you are paying on a schedule other than monthly, use that amount of time rather than months to compute the formula.
If you have an annual interest rate rather than a monthly one, divide it by 12 to find the monthly rate, since there are 12 months in a year.
If you'd rather not apply the formula directly, you can use various online calculator tools to compute the amount owed per month. You can also use the Microsoft Excel function PMT to find the monthly payment without having to do the math yourself.
Handling Installment Loan Payment Issues
If you find you can't keep up with the payments on an installment loan or any other loan, you may be able to negotiate with the lender for a longer payment schedule or some other loan modification. Keep in mind that if you make less than the required payments on a loan or stop paying, it may affect your credit rating or your ability to borrow in the future.
For example, there may be a Fannie Mae loan modification waiting period before you can take out another mortgage backed by the organization after a negative credit event.
Steven Melendez is an independent journalist with a background in technology and business. He has written for a variety of business publications including Fast Company, the Wall Street Journal, Innovation Leader and Ad Age. He was awarded the Knight Foundation scholarship to Northwestern University's Medill School of Journalism.