Before taking out a loan, it’s important to understand how the loan repayment will work and how much your monthly payments will be. With amortized loans—which includes many consumer loans—each payment gets split into an interest payment and principal payment. Your repayment model will vary depending on the type of amortization method your loan follows.
A fully amortized loan is a loan that’s paid off over a predetermined period—the loan’s repayment term—with scheduled payments that are applied to both the interest and principal balance.
Amortization refers to the gradual process of paying off a loan balance with regular payments. Mortgages, personal loans, student loans, and auto loans are often amortizing loans with fixed monthly payments, fixed interest rates, and a predetermined repayment term.
More interest accrues in the beginning of the loan term, when the principal balance is at its highest. As a result, most of your payment goes toward interest.
As you pay off the loan, the amount of each payment that goes toward the interest and the principal balance slowly shifts. By the end of the loan term, only a small portion of the loan payment goes toward interest.
Lenders can use different types of amortization methods to create a loan’s amortization schedule or table. Though commercial and business loans have their own amortization methods, there are several types of amortization that you’ll want to be aware of when it comes to consumer loans.
A fully amortized loan is a loan that will be completely paid off by the end of the amortization period. When the loan has a fixed interest rate, you’ll have equal payments for the lifetime of the loan, though the final payment may be a little larger or smaller depending on your remaining balance. Many personal loans and mortgages are fully amortized loans with fixed interest rates and payments.
Fully amortized loans can also have a variable interest rate, which is the case with adjustable-rate mortgages (ARMs). For example, a 5/1 ARM could have a 30-year repayment term with a fixed rate for the first five years, and then its interest rate can change once a year. Each time the rate changes, the loan is re-amortized, and a new amortization schedule is created. As a result, you’ll still pay off the loan in 30 years, but your subsequent payments may increase or decrease when the loan’s rate changes.
Some partially amortized loans may feature interest-only payments for a period of time before transitioning to fully amortizing payments for the remainder of the term. For example, if a loan had a 30-year term, the first 10 years might only require the client to make interest payments. After that, principal and interest payments would be made for the remaining 20 years or until the loan was paid off. Some home equity lines of credit (HELOCs) may have an interest-only draw period followed by a fully amortized repayment period.
There are also some partial amortization loans that follow the initial period of deferment or interest-only payments with a balloon payment. Balloon payments were more common with consumer mortgages before the Great Recession and may still be available to some borrowers. But keep in mind, a balloon payment is more than two times the loan’s average monthly payment, and can often be tens of thousands of dollars. If you’re considering a loan with a balloon payment, you’ll need to consider whether you can make the balloon payment when it comes due.
Negative amortization is when your payment doesn’t cover the amount of interest due. As a result, your total balance can increase even if you make your full payment on time. Sometimes, the unpaid interest gets added to your loan’s principal balance, which leads to a larger interest expense during the next period.
Many consumer installment loans are amortized loans. In many cases, you can choose the repayment term when taking out the loan, which will determine your amortization period. Here are four common examples:
Many personal loans are unsecured installment loans with fixed interest rates. With LendingClub Bank, you can check your loan offers without impacting your credit. After reviewing your offers, you may be able to choose a personal loan with either a three- or five-year term.
Home loans are often fully amortized loans with either a 15- or 30-year mortgage term. While the amortization schedule will show you every payment over the term, many people move or refinance their mortgage before paying off the loan. With an adjustable-rate mortgage, your loan may be automatically recast every time the interest rate changes.
Car loans are secured by the vehicle you’re buying and amortized for the life of the loan. If you’re buying a new car and have good credit, you may qualify for a 0% APR promotional rate, which means the entirety of your payments will go toward the loan’s principal during the promotional period.
Federal student loans have a variety of special features that can impact your monthly payment and amortization schedule. For example, you can defer payments while you’re in school and choose from different repayment plans. Using an income-driven plan might lead to negative amortization. However, under certain repayment plans, the government might pay part or all of the interest owed, which will keep your outstanding balance from growing.
There are also non-amortized consumer loans and credit products. A non-amortizing loan is a type of loan or credit where payments are made periodically on the principal balance. For example, you may have a minimum monthly payment on a credit card or revolving personal line of credit. However, your account doesn’t have a fixed payoff date or monthly payment amount.
Your loan’s amortization schedule shows how your payments get divided between interest and the loan’s principal balance. Understanding how this works can help you make more educated decisions about managing your debts.
An amortized loan can be easier to manage than other types of debt because you’ll know exactly when you’ll pay off the loan. If it has a fixed interest rate, you’ll also know your payment amount for the lifetime of the loan.
The loan amortization schedule shows how much of each payment will go toward interest and the principal balance. As you pay down the principal balance, less interest accrues, and a larger portion of your payment will go toward the principal.
A loan’s interest rate, repayment plan, and whether it’s amortized doesn’t directly impact your credit reports or scores. But the loan may help your credit if you make your payments on time or hurt your credit if you fall behind. 1
1Reducing debt and maintaining low credit balances may contribute to an improvement in your credit score, but results are not guaranteed. Individual results vary based on multiple factors, including but not limited to payment history and credit utilization.
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