What is Amortization?
Discovering how your amortization schedule works is
an important step in understanding the basics of your
loan. Here’s a look at what is amortization and how it
Amortization is loan repayment that’s based on equal monthly payments each month. Each payment is
made up of interest and principle payments. Amortization schedules are typically made in such a way
that most of the loan interest is paid earlier in the loan, with little going toward the principle balance. The
interest portion of the payment decreases a little each month and principle payments increase. Using an
amortization schedule lets both the borrower and the bank see how the loan will be paid over the
repayment period.

Looking at an amortization schedule for your loan, you’ll see that the total amount repaid is larger than the
amount you borrow. That’s because you must pay a cost to borrow money. That cost comes in the form
of interest. Interest is front-loaded on the loan repayment allowing the bank to collect their fee quicker.
Auto loans are typically amortized over a 3- to 5-year period of time. Mortgage loans are usually
amortized in 10-year, 15-year, 20-year, or 30-year time periods.

How Amortization Period Affects Loan Amount

If the amortization period is longer, your payments will be smaller, but in turn you’ll pay a greater amount
of interest relative to what you borrow. On the other hand, shorter amortization periods mean bigger
monthly payments with less interest paid over the life of the loan. You can pay off your mortgage faster
than scheduled – and thereby pay less interest – by paying more than the balance due. Before you send
extra payments, make sure your mortgage doesn’t have a prepayment penalty, which would asses you a
fee for paying off your mortgage sooner than scheduled.

Non-Amortizing Loans

Mortgages that have interest-only payments are not
amortized for the period that the principle is not being
reduced and the borrower is not gaining any equity in the
asset the loan is used to purchase. Typically, the
payments increase after a certain amount of time so the
loan amortizes on schedule.

Negative Amortization

A loan payment is called “fully amortized” if making that
payment each month would result in loan repayment by
the end of the term. However, some mortgage payments
are below the fully amortized payment and result in an
increase in the principal balance. This happens because the monthly-required payments are less than
the interest due based on the amortization schedule. The deferred interest is added back to the loan and
the balance grows instead of shrinks. This can happen with both fixed and adjustable rate mortgages in
graduated payment and payment option mortgages, respectively.

The downside of negative amortization is that the monthly payments must increase at some point in the
mortgage so the loan can amortize on schedule. Loan payment may increase significantly several years
into the loan resulting in payment shock. Or, there may be a one-time balloon payment due on the
mortgage due several years into the loan. If you can’t afford the increased mortgage payment or the
balloon payment and you can’t refinance your loan before the payment is due, you risk losing your home
in foreclosure.

Some borrowers benefit from negative amortization mortgages because the initial payments are low and
affordable. However, these do not come without risk. Borrowers with these types of mortgages must be
aware of the impending payment increase and be sure they can afford the increased payment when the
time comes.

The loan may have a negative amortization limit that’s either a fixed amount or a percentage of the loan.
Your loan payment will automatically adjust so the loan can be fully amortized by the end of the repayment

Using an Amortization Calculator

You can use an online amortization calculator or this amortization schedule spreadsheet (Excel) to print
an amortization schedule based on your loan amount, interest rate, and repayment period. The
amortization table will let you know your total monthly payment, the amount of the payment that goes
toward interest, the amount of the payment that goes toward principle, and the amount of principle owed
after making each monthly payment.
Copyright © 2011 The Money Alert.com. All rights reserved.
All information herein has been prepared solely for informational purposes, and it is not an offer to buy or sell, or a solicitation of an offer to buy or sell any security or instrument or to
participate in any particular trading strategy. The Money Alert does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any
information prepared by any unaffiliated third party, whether linked to this web site or incorporated herein, and takes no responsibility. All such information is provided solely for
convenience purposes only. The Money Alert is not affiliated with any of the firms or entities listed unless specifically stated. The Money Alert does not provide investment, tax or legal
advice. Please consult the appropriate professional regarding your personal situation.
What is Amortization