When it comes to borrowing money, the first thing you need to consider is your affordability. While there are various short-term loans claiming to be affordable, it often becomes arduous to choose a deal that suits your needs.

Short-term loans like payday loans that require you to pay back the whole of the money are notorious, which is why borrowers look forward to take out instalment loans in the UK. This is a common belief that you will pay off the loan instalments unless the term ends and hence they are much more affordable than other small loans.

There is no doubt that loans can strain additional pressure on your financial health. It seems difficult to stay afloat, but your irresponsibility also accounts for it. If you borrow more than your affordability, it is natural you will fall in a predatory debt spiral, no matter you need to pay it off in lump sum or instalments.

Your knowledge is limited if you only know that an instalment loan requires you to pay down in fixed instalments.  Both amortised instalment loans and non-amortised instalment loans are different from each other.

What is amortisation?

Amortisation is a process of spreading out your loan into a series of instalments that include both the principal and interest. In other words, the debt size will continue to shrink. Amortised instalment loans come with two payment plans depending on the policy of the lender.

  • Equal principal payments
  • Equal total payments

A lender may generally ask you to choose between these methods. However, the most common method is the latter. If you choose the former, your total payment will be different each time that makes difficult to create a budget accordingly and hence people prefer opting for equal total payments.

Suppose you have borrowed £1,000 to be paid three months at the interest rate of 6%. Your payments will be as follows:

If you choose the first option

Period Total payment (£) Principal amount (£) Interest amount (£) Balance owed (£)
1 383.33 333.34 5.00 666.67
2 336.66 333.34 3.33 333.34
3 335.01 333.34 1.67 0.00

If you choose the second option

Period Total payment (£) Principal amount (£) Interest amount (£) Balance owed (£)
1 336.67 331.67 5.00 668.33
2 336.67 333.33 3.34 335.00
3 336.67 335.00 1.68 0.00

Are all instalment loans amortised?

Not all instalment loans are amortised in nature. An amortised loan is the one that reduces in size with each instalment. There are mainly two types of instalment loans: short-term loans and long-term loans.

Short-term instalment loans do not allow you to borrow money more than a year and long-term instalment loans can be repaid over a period of 15, 20, 30 or 40 years. Short-term instalment loans do not come with amortised feature. It means your each instalment will go toward the interest only and at the end of the term of the loan, you will pay off the whole principal.

When you take out an instalment loan, make sure that your lender provides you with amortisation facility. Mainstream lenders do not provide this feature because it gives them a chance to make extra profits.

Once you have paid the entire interest, the lender has got money back even though you still owe principal. Some lenders use the instalment feature as a bait to trap you in a predatory cycle of debt.

It is not surprising that you face difficulty paying the principal in lump sum at the end of the term that forces you to roll over a loan. It gives a new chance to the lender to charge interest on what you owe and this cycle unfortunately continues.

If you do not get amortised short-term instalment loans, make sure that you have stashed away the principal amount to settle your debt without any difficulty.

The final word

Amortising loans are mainly long-term loans. Credit card debt and interest only loans never fit in this category. Even if you are applying for short-term instalment loans, you need to be very careful with your repayment plan.