Section 8.2 Installment Loans
277
business. It is common for a lender to require that some of the purchase amount
be paid up front by the borrower, rather than fi nancing the entire purchase price.
The down payment is the amount the borrower pays up front. The amount
fi nanced is the remaining cost that will be covered by the loan. The amount
fi nanced is calculated as follows:
amount fi nanced = purchase price – down payment
There is no consistent rule
governing the amount of a down
payment. Depending on what is being
purchased, a lender may require as
much as 20% down. Some loans require
a smaller down payment. You probably
have heard advertisements promising
no down payment on purchases.
You may be asking why a down
payment is required. The reason is that
when you fi nance a purchase with an installment loan, the item purchased is
generally used as collateral for the loan. The down payment reduces the risk for
the lender. Should the borrower not be able to pay back the loan and the lender
has to sell the asset to cover the loan, the lender hopes that the asset is worth
more than the balance on the loan. The higher the down payment, the more
likely the asset’s value will cover the balance of the loan. Also, as payments are
made each month, the principal is further reduced, which makes it more likely
that the value of the asset is higher than the principal balance.
Example 8-2B
See It
Mali wants to purchase a new boat that costs $14,995. She wants to fi nance
her purchase. The bank wants a down payment of 15%. Determine both Mali’s
down payment and the amount that Mali will be fi nancing.
Strategy
Use the formulas:
down payment = purchase price × down payment rate
amount fi nanced = purchase price – down payment
Solution
Step 1: Convert the down payment percentage to a decimal by moving the
decimal two places to the left.
15% → 0.15
fyi
During the fi nancial crises
that began in 2008, the
value of many houses fell
to less than the amount
left to be paid on the
mortgage loans. When
the value of an asset
is worth less than the
amount owed on the
loan, it is often referred to
as being under water.
Installment loans are diff erent than other types of
loans because they generally do not require collateral.
Most installment loans are used to purchase items
such as furniture or equipment. These loans are
usually short-term and range from 3 to 24 months for
repayment. Installment loans are fairly easy to obtain
but may not be available in all states. Generally, there
is no prepayment penalty if the loan is paid before the
end of the term.
F F F F F F F F F F F F F F
i i i i i i i i i i i i i
n n n n n n n n n n
a a a a a a a a a a
n n n n n n n n n n
c c c c c c c c c c
i i i i i i i i i i i i i i
a a a a a a a a a a
l l l l l l l l l l l l l l
$ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $
m m m m m m m m m m
a a a a a a a a a a
r r r r r r r r r r
t t t t t t t t t t t t t t
s s s s s s s s s s s
Financial
$marts