What is Loan Amortization?

If you are wondering what loan amortization is, it’s a loan with scheduled periodic payments of both principal and interest. This is opposed to loans with interest-only payment features, balloon payment features and even negatively amortizing payment features.

The Benefits

Borrowers who choose amortized loans are less likely to experience “payment shock” than borrowers who choose loans which are not fully amortized. Payments on loans that are not initially fully amortized must at some point become amortized over the remaining term of the loan in order to repay the outstanding principal balance. The shorter the remaining term, the larger the increase required in the periodic payments to amortize the loan over the remaining term.

The primary advantage of amortized debt is that with each payment, the borrower builds equity in the asset. After the final payment, the borrower owns the asset.

If the loan has a fixed interest rate, the borrower’s payment amount never varies. The main disadvantage is that the monthly payments can be high since both principal and interest are paid. If the amortized debt has a high interest rate and interest rates drop, the borrower is stuck with an excessively high rate.

If you want to experience the possible benefits for yourself, use a calculator to see the results.

Amortization Table

The amortization table displays the breakdown of the monthly bond repayment into an interest and capital portion over the entire bond period. It also reflects the outstanding capital amount at the end of every month during the bond period.

Near the end of the bond period, the monthly bond repayment consists almost entirely of capital. It is interesting to note the percentage of capital which is outstanding throughout the bond period – generally, after 10 years of bond repayments, more than approximately 80% of the original capital will still be outstanding and after 15 years, more than approximately 50% will still be outstanding!