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What is Loan Amortization?

Loan amortization is a financing option that allows borrowers to pay off their loan over a specified period. With each payment, you will make progress paying down both the interest and the outstanding loan principal.

September 1, 2021

When you consider taking out a new loan, there are a lot of important factors to think over. While interest rates may capture most of your attention, you should also note what type of loan you’re applying for. 

Repayment structure will play a major factor in how much you spend over the life of a loan and what your repayment schedule will look like. While loan shopping, chances are you’ll come across amortized loans. 

Not sure how this loan is different from others? Keep reading for answers to these top questions:

  • What does an amortized loan mean?

  • What is a loan amortization schedule?

  • How do you calculate loan amortization?

What does an amortized loan mean?

If you’re shopping for loans, you need to be able to answer the question, “What is loan amortization?” 

In short, loan amortization is a financing option for borrowers to pay off their loan over a specified period. Payments throughout the life of the loan will be consistent. With each payment, you will make progress paying down both the interest and the outstanding loan principal. As time goes on — and interest is paid down — more of the payment will go towards the loan principal until you fully pay your loan off.   

With loan amortization, you can make additional payments on top of your minimum monthly payment, and the extra payments will go towards the principal. That means if you can make extra principal payments, you’ll be able to save on interest over the life of the loan.  

These are a few types of common amortizing loans: 

  • Auto loans

  • Home equity loans

  • Student loans

  • Personal loans

  • Fixed-rate mortgages

While amortizing loans are widespread, there are a few other types of loans you may encounter. Two other common options that differ from amortizing loans are unamortized loans (which have balloon payments) and revolving credit.

Amortized vs. Unamortized debt

With an unamortized loan, you only make payments on interest during the loan period, which can keep your monthly payments on the lower side. However, you may have to make a final balloon payment to cover the total principal amount at the end of your loan term. These balloon payments can be difficult to make all at once, so it’s important you have a plan in place to save up for them or make extra payments to help pay down the principal throughout the life of the loan. 

Unamortized loans can include:

  • Interest-only loans

  • Home equity lines of credit

  • Credit cards

  • Varying types of loans that come with a balloon payment

  • Any loans that allow for negative amortization (where your monthly payment ends up being less than the accrued interest)

You have a set credit limit with a revolving credit account, and you can choose how much you pull from that credit account. When you pull money from it, you also get to decide to pay off your balance each billing cycle in full or carry the balance over to the next month. The latter option is known as revolving a balance. 

When you revolve a balance, you end up making a minimum payment each month (like with credit cards) and are charged interest on the balance you carried over. Fees can also pop up here, including late payment fees, origination fees and annual fees. 

A few common types of revolving credit include:

  • Credit cards

  • Personal lines of credit

  • Home equity lines of credit (HELOCs)

What makes loan amortization unique?

With the question, “What does amortized loan mean?” answered, we can examine the benefits of these loans. One of the reasons loan amortization stands out is how convenient and straightforward it is for consumers. 

Essentially, loan amortization takes your loan balance and divides it into equal payments on a set repayment schedule. That way, you’ll know exactly how much you’ll need to pay in interest and the exact date your loan should be paid off (assuming you make all of your payments). 

Borrowers may find that loan amortization is helpful when it comes time to incorporate their debt payments into monthly budgets. One of the more unique features of loan amortization is that the loan amortization schedule can be illustrated in a table, known as an amortization table, that helps borrowers calculate how much money they can save on loan interest by making extra payments. 

An amortization table can help you stay organized, as it includes all of your scheduled payments and how much of each payment goes towards interest and the principal. Usually, you’ll find the following information included in an amortization table.

  • Loan details (total loan amount, the loan term and interest rate)

  • Payment frequency

  • Total payment

  • Extra payments 

  • Principal repayment

  • Interest costs

  • Outstanding balance

How is each monthly payment calculated? 

If you know how much you need to borrow but aren’t sure how much your monthly payments will be, you can get a general idea of what to expect by using an amortization table to calculate your monthly payments. There are plenty of calculators you can find online that can help you make these calculations, but you can also do the math on your own. 

To understand how to calculate loan amortization on your own, so you can figure out what your monthly payments will look like, you’ll need the following information at the ready:

  • A = total loan amount

  • N = total number of payments (number of payments per year x length of loan in years)

  • R = Monthly interest rate (annual rate / number of payments per year)

With that information, you can then use this equation to calculate your monthly payments: 

a / {[(1 + r)n]-1} / [r (1+r)n] = p

If you haven’t met with a lender yet, you’ll likely need to estimate your monthly interest rate and the total number of payments. But, if you plug in a few best guesses, you’ll get a pretty good idea of what your monthly loan payments will look like before you even meet with a lender. 

Sick of having to plan for credit card debt payments? Learn more about how Tally can help you save money and pay down your debt faster!