Installment financing is by far the best-known form of financing and most people will have used it at least once. This type of financing is mainly encountered when purchasing consumer goods or as an offering from banks and is often referred to as an installment loan.
The borrower pays a predetermined portion of the total amount plus any accrued interest each month. These partial payments are also called installments.
The amount of the installment depends on several factors, which can affect the total either individually or in combination, even if the loan amount and the term remain the same.
Since installment financing consists largely of standardized offers, the terms are standardized as well. The loan amount refers to the amount paid out to the consumer.
Another important parameter is the term of the installment financing. Depending on the lender's offer, these range from a few months to several years. The interaction between the loan amount and the term are the two most important parameters for determining a monthly payment. The third pillar to consider in installment financing is the annual interest rate. This is used to calculate the total amount for the installment financing.
Example of Calculating an Installment Loan
Calculating the total amount of an installment loan is very simple even for laypeople if you know the mathematical formulas behind it.
Also take a look at our Guide to calculating interest! There you will also find tips on how to build an interest calculator in Excel yourself. The example given there also includes a differing final installment. Such an interest calculator is particularly useful for an initial calculation for long-term loans such as mortgage financing.
Of course, you can also use our loan calculator to calculate the monthly payment for your desired amount and term.
Here is an example for calculating an installment financing of €3,000 over 36 months at an annual interest rate of 6% — this corresponds to a monthly interest rate of 0.5 percent.
In the first step, the total amount of interest is determined using the following formula:
Interest = (annual interest rate / 12 / 100) x term x loan amount.
Interest = (6 / 12 / 100) x 36 x 3000 = €540.
The interest expenses over the entire loan term therefore amount to €540.
In the second step, the total financing costs and the monthly installments are determined using the formula "loan amount plus interest divided by term". Applied to the previous example, the calculation looks as follows:
(3000 + 540) / 36 = €98.33 monthly payment.