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Amortization
16 Sep 2019

Amortization: Here’s How It Works

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Loans and personal finance can be a daunting experience, especially if it’s your first time applying or paying or a loan.

You aren’t alone, since the U.S. ranks 14th in financial literacy, despite having the world’s largest economy. This financial illiteracy also adds to the difficulty of choosing the right types of retirement plans according to the Global Financial Literacy Excellence Center.

Below we’ll go over what amortization is and what it means for you when paying off an installment loan.

What is Amortization?

Amortization involves establishing a regularly paid monthly plan of equal amounts that will allow a borrower to be able to pay off both of the following

  • The principal payment: a payment towards the unpaid principal balance will allow your total balance, including the interest generated every month, to go down over time to the point where it will reach zero in the allotted time given.
  • The interest payment: a payment based on the interest generated from the unpaid principal balance.

Payment for the principal will allow for a decrease in the total interest gained, so over the fixed amount of time the entire balance will equate to 0.

Amortized personal loans provide a borrower with clarity and an extremely clear picture of how much is owed per month. This makes these loans appealing for those who need their payments to be consistent. People who receive paychecks regularly at a consistent amount every month will like amortized loans as they can plan ahead for the next few months/years.

Some examples include car loans, mortgages, and student loans.

Amortized vs. Unamortized Loans

So when do unamortized loans make sense?

While an amortized loan is beneficial and more commonly offered to people, everyone’s situation is unique. Some of the big benefits for amortized loans is that you may gain equity in the asset itself since you’re paying down both the interest and the principal. This is the case with loans like mortgages and cars.

The drawbacks to amortized loans are that while payments won’t change month to month, the amount itself is relatively high because you’ll be paying off both principal as well as the interested generated by that principal. This can put a lot of financial strain on someone who is currently struggling.

Unamortized bad credit loans can be a better option for some due to the lower payments. You won’t be paying any principal, so it’s not a long-term solution. You’ll ultimately pay more over time.

However, the low affordable payments can help you manage your finances until you can save up enough to pay more. This can be good for those who have variable income or deal with lump-sum payments like those on commission.

Are Amortized Loans Right For You?

It’s important to shop around and take a look at your financial situation to see which type of no credit check loan is best for you. This means figuring out how much you can realistically afford over what period of time. Amortization can work for or against you, depending on your situation.

If you’re interested in learning more about personal finance, take a look at our blog.

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