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How Does an Installment Loan Amortization Schedule Work?

Written by
Alex Huntsberger
Alex Huntsberger is a personal finance writer who covered online lending, credit scores, and employment for OppU. His work has been cited by, Business Insider, and The Motley Fool.
Read time: 5 min
Updated on May 10, 2024
woman in office wondering how does an installment loan amortization schedule work?
When an installment loan has amortizing interest, every payment you make brings you one step closer to getting out of debt.

Finance is complicated, and it seems to grow more so by the day. The less you know about how a financial instrument like a loan or credit card works, the more likely you are to make a mistake or get taken advantage of.

Don’t worry, we are here to help! In this post, we will cover amortization schedules, which are key to understanding how installment loans work, and why they can be a better option than a short-term alternative.

How does interest work?

Before we get to amortization, we first need to talk about interest, which is the amount that you are obligated to pay back on a loan beyond what you borrowed. Interest is normally expressed as a percentage of the total principal loan amount. When repayment of a typical loan is due, you pay back the amount you borrowed plus the accrued interest.

Interest for installment loans is more complicated.

With an installment loan, interest on the loan accrues over time instead of being charged as a flat fee (to learn more, read the OppU Guide to Installment Loans).

It’s useful to know the loan’s annual percentage rate, or APR, which measures the cost of a loan, including interest and certain fees, and is expressed as a percentage over a calendar year. For instance, a $1,000 online loan with a 10% APR would accrue $100 in interest every year that it's outstanding.

Except that’s not actually what happens. See? We said this was more complicated.

Installment loans are paid off in a series of regular payments, often weekly, biweekly, or monthly. Every payment reduces the principal loan amount, and the interest is calculated as a percentage on the remaining balance.

Since the total amount you owe decreases with each payment, the interest charged is also reduced. For example, 10% of $1,000 is $100, but 10% of $900 is only $90.

Back to that original loan; if you were to borrow a one-year $1,000 personal loan with a 10% APR, you would only end up paying $56 in interest.

What is amortization?

Amortization is another feature of installment loans. When a loan is amortized, every payment goes towards both the principal and the interest owed. Every timely payment would get you closer to being debt free.

At the beginning of your loan, the odds are good that a large fraction of your loan payment will be applied toward the interest owed.

However, with every payment made on that amortized installment loan, the ratio between the interest and principal shifts; over time, the payment amount going toward the interest decreases while the payment amount going toward the principal increases.

Typically, the last payment on the loan will be almost entirely principal and just a tiny sliver of interest.

Paying off the loan early, could end up saving a significant amount of money in interest assuming that the loan doesn’t carry prepayment penalties.

What’s an amortization schedule?

There is a formula that governs amortized loans, keeping consistent payment amounts while balancing the ratio of interest to principal and, most importantly, ensuring that the loan will be paid off in full by the final due date.

As such, you can create a chart that lays out every payment during the loan's repayment term and captures the amortization process in action. This is known as an amortization schedule, and it will include the following for each scheduled payment:

  • Starting balance
  • Payment amount
  • Principal paid
  • Interest paid
  • Ending balance

Many lenders provide borrowers with an amortization schedule as a part of their loan agreement. It allows customers making timely payments the ability to track exactly how much they still owe on their loan and how each payment is bringing them closer to paying off the loan.

The dangers of unamortized loans.

There are many ways in which unamortized loans can add both increased risk and additional expense. “Interest-only” and “balloon” loans, for instance, are two types of non-amortized loans that come with low initial payments and much larger payments later on. However, those risks and costs are slightly different with bad credit personal loans.

Since interest charged on a payday or title loan is generally a flat fee, there is not a “interest-saving” benefit to paying off the loan ahead of time; still, an early payoff means you will have less debt. Their lump-sum repayment structure, meaning that the loan is paid off in a single payment, can also make these loans less affordable for many consumers.

When customers cannot afford to pay off their payday or title loan on time, they might feel forced to roll over their loan, extending the due date in return for a new round of interest charges. Oftentimes, all they have to do is pay off only the interest already owed to do so.

This is how borrowers become trapped in a cycle of debt; they keep making payments on their no credit check loan, but none of that money goes toward the actual amount owed. Instead, they’re just paying off the interest and deferring the principal for later.

Simplicity can be overrated.

Most folks like to keep things simple. In that respect, people may think short-term payday loans beat amortized installment loans. Amortization schedules aren’t that complicated, but they can certainly seem that way.

Then again, just because something’s simpler doesn’t mean it’s better. In cases like these, it just might be the opposite.

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