Not All Loans Are Created Equal

All of us have a story about how we did something stupid with our money. Even though these lessons hurt, it’s best to treat them as the cost of education, and to learn from them. As you grow your wealth of understanding, consider learning from others instead of making the mistakes yourself.

One of the more expensive lessons I learned was that not all loans are created equal.

You probably already know that loans come with different “APR” (annual percentage rate) and that directly effects your monthly payment and the amount of interest you have to pay the lender. As a rule of thumb, lower is better.

But did you also know that loans can differ in the way you pay interest?

Loans have what’s called an Amortization Table (sometimes called Amortization Schedule) that shows what days your payments will be due, and what portion of the payment goes to the principal (what you owe) and what portion goes to interest (the lenders payment for loaning you money).

And this is where I messed up.
At the time, I already had a mortgage (home loan) and had looked at the Amortization Table for that loan. And to my discouragement, lenders really front load those loans with interest payments.

Home Loan Amortization:

Payment DateAmountInterestPrincipalRemaining Balance

You can see that you pay more in interest than you actually pay down the loan. It’s this way for the first 41 months.

They say you pay the bulk of the interest on a home in the first 5-7 years. And that’s not an arbitrary number that they just picked out of thin air. That happens to be the amount of time the average person lives in a purchased home. So every time you move, this process of paying mostly interest starts all over.

I knew loans were often front-loaded with the interest, but a couple of years ago, when I made a large purchase for something that I didn’t have cash for at the time, I signed a financing agreement (loan) and the only thing I looked at was the APR. I got a good rate, so I thought the loan must be good.

Plus, I knew I’d have enough cash to pay it off in about two years, so I wouldn’t have to finance the full amount–I’d pay the loan off early and save some interest.

Boy was I wrong. It wasn’t until 3 months into it that I looked closely at my statement and saw that my Remaining Balance hadn’t gone down… at all. I thought there was an error so I sent the lender a message.

The error was all on my end. I hadn’t looked at the Amortization Schedule to see that the first 16 payments were “interest only” and I wouldn’t begin to pay down the principal (or what I owed them) until month 17.

Bad Loan Amortization Schedule:

Payment DateAmountInterestPrincipalRemaining Balance

This completely blew up my plan to pay this loan back early after a couple of years. The damage was being done the most in those first two years.

With most home loans you can save thousands of dollars by paying a loan back early. But with this terrible (for the borrower) amortization schedule I paid through the nose to finance something that I didn’t really need.

I hope you can learn from my mistake and avoid bad loans. And if you have to take out a loan, remember to look at the Amortization Schedule and know that there’s more to a loan than just the interest rate.

-Wealth of Understanding