Is Your Bad Credit Loan Amortized? If It’s Not, Here’s Why It Should Be

If you think all bad credit loans are the same, you are sorely mistaken. Non-amortized loans can easily trap borrowers in a dangerous cycle of debt.

Oftentimes, when people need a bad credit loan, it’s because they’re in the midst of a financial emergency. A family member has ended up in the E.R. or their car has suddenly died and they need to get it fixed pronto.

Whatever the reason, it’s not a situation that lends itself to careful shopping around. When the pressure’s on, folks are much more likely to pick the first loan they see and get on with it.

As you might have guessed, this kind of slap-dash decision-making can leave you with brand new financial headaches to deal with. If you have bad credit, choosing the wrong bad credit or no credit check loan can end up trapping you in a recurring cycle of debt.

There are many things to consider when choosing a loan for bad credit, but here’s why amortizing interest should be near the top of your wish-list.


What is amortization?

Anyone’s who’s learned how to drive (or taught someone else) has had to deal with the fact that some words—like “right,” for instance—can have different meanings depending on how they’re used. And the same is true for the term “amortization.” Depending on the context, it can mean some very different things.

One of these definitions has to do with how assets are valued, primarily for tax purposes. It’s slightly complicated and has very little to do with regular ol’ personal finance. That’s why we’re not going to talk about it here.

The other primary definition of amortization has to do with the way that loans are repaid. That’s the thing we’re interested in. Amortizing loans are paid off in a series of regular installments, with each installment going towards both the principal loan amount and the interest.

Early on in the loan, the majority of each payment goes towards the interest, while only a small amount goes towards the principal. But with every payment that’s made, this ratio shifts slightly in the other direction, until the last few payments on the loan are almost entirely paying down the principal. This process all unfolds according to a timetable called an  “amortization schedule.”

The interest for these loans also accumulates over time, so the smaller your principal, the less money in interest it accrues. At the beginning of the loan term, the principal is racking up a fair amount of interest. By the end, however, it isn’t racking up much interest at all.

This all might seem rather technical, but when you’re dealing with bad credit loans—where even the more affordable products come with much higher interest rates than regular personal loans—the difference between amortizing and non-amortizing loans can be huge.

Short-term vs. long-term loans.

Bad credit loans come in two distinct flavors: short-term and long-term. Short-term loans have payment terms that average around two weeks to a month and are structured to be paid back in a single lump sum. Common types of short-term bad credit loans include payday loans, cash advances, and title loans.

Long-term bad credit loans, on the other hand, generally come with payment terms anywhere between six months and a few years. These are generally referred to as installment loans, and their payment structures are almost indistinct from regular personal loans and auto loans.

Because short-term bad credit loans are paid back all at once, they are not amortizing. They do not accrue interest over time and that lone payment pays back everything, both the principal and the interest. Charging interest as essentially a flat fee means that paying back these loans early won’t save you any money.

On the other hand, paying off a bad credit installment loan early will save you money—so long as it doesn’t carry a prepayment penalty. The less time your loan principal has to accrue interest, the less money you will end up paying overall.

But being able to pay off any loan early is a best-case scenario, and it’s not wise to choose a loan based solely off of what can happen if everything goes right. Instead, you should look at what happens if you pay the loan back as scheduled. And when you do that, amortizing installment loans still carry a clear advantage over their short-term cousins.

Avoiding the payday cycle of debt.

With short-term payday, cash advance, and title loans, the cost of the loan can be minimized if it’s paid off on time. A 15 percent interest charge on a two-week loan might work out to an APR of almost 400 percent, but when paid off on two weeks, it’s still only $15 per $100 borrowed.

The problem is that many bad credit borrowers aren’t able to pay these loans off on time. Instead, they are either forced to reborrow their loan—meaning that they pay the original loan off and then immediately borrow a new one—or they have to roll it over, which is possibly worse.

Rolling over a loan means getting an extension on the due date in return for being charged additional interest. Oftentimes, the borrower will also be asked to pay the interest owed on the original loan term in order to secure the extension and then owes an entirely new round of interest on a new loan term. Basically, rolling a loan over once doubles your interest rate.

This whole process, wherein the borrower keeps taking out new loans and only paying off the interest, is referred to as a cycle of debt. Since none of their payments are going towards the principal, they’re not actually making progress towards getting out of debt, no matter how much money they pay.

According to a study from the Consumer Financial Protection Bureau (CFPB), the average payday loan customer takes out 10 loans annually and spends almost 200 days every year in debt.

This is exactly the sort of situation that an amortizing loan is constructed to avoid. So long as you make your scheduled payments, paying off the loan principal takes care of itself. Even if you refinance the loan and extend your repayment term, those new payments will also follow an amortization schedule.

No loan is going to be perfect, especially when you have bad credit, and there are plenty of things you should look for in a loan and a lender before signing any loan agreements. But when you take the financial long view—instead of just focusing on your immediate cash needs—you’ll see that choosing an amortizing installment loan is a no-brainer.

To learn more about managing your finances when you have bad credit, check out these related posts from OppLoans:

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The information contained herein is provided for free and is to be used for educational and informational purposes only. We are not a credit repair organization as defined under federal or state law and we do not provide "credit repair" services or advice or assistance regarding "rebuilding" or "improving" your credit. Articles provided in connection with this blog are general in nature, provided for informational purposes only and are not a substitute for individualized professional advice. We make no representation that we will improve or attempt to improve your credit record, history, or rating through the use of the resources provided through the OppLoans blog.