What are the Pros and Cons of Amortized Loans?
When finance professionals talk about amortized loans, they are referring to a modern process of breaking down a conventional loan into easy monthly payment schedules. In amortized loans, the entire interest and principle are combined to form stable monthly payments that, given a fixed rate of interest, do not vary. Amortized loans are popular with larger loans; although a car loan may in some cases be amortized, a mortgage is a prime example of an amortized loan, and most mortgage companies insist on amortizing their loans.
Amortized loans have distinct benefits and disadvantages. Some borrowers love them, and others do not. Many of the benefits relate to how easy amortized loans are to pay. Many of the drawbacks focus on specific issues around clarity in lending.
One of the main good points about amortized loan setups is that they offer a clear, set monthly payment to the borrower. The amortized loans are also often easier to track, since the payment amount for each month is a given, where irregular payments could cause a lot of confusion. The inclusion of an amortized standard in mortgage lending also contributes to a more straightforward process.
Some borrowers and others point out that the current system in many nations of using an amortized loan system is not perfect. For some beginning borrowers, a non-amortized loan would be easier to understand. There’s also a major issue around equity; equity is the amount of capital that gets built up as borrowers pay off the loan. With an amortized loan, the equity does not build up “on the front end,” meaning that even if the borrower holds onto a property for several years, their equity in that property will be very low, given a lack of forward payments.
Another major negative discussion point on amortized loans related to the idea that amortization goes against various lending principles established by consumer advocates. For smaller loans like car loans, personal loans, or payday loans, leaving a loan in the form of a “monthly payment” is often deceptive to the borrower. It doesn’t address how much money the borrower will pay on the initial debt over the term of the loan. Some see this as taking advantage of a borrower, and do not recommend amortization for smaller loans. This issue can be resolved when lenders include supplementary information in an amortized loan agreement that clearly shows borrowers what they will pay in total, and how to avoid greater interest on that loan by prompt repayment.
Discuss this Article
Post your comments