What is an 'Amortized Loan'

An amortized loan is a loan with scheduled periodic payments that consist of both principal and interest. An amortized loan payment pays the relevant interest expense for the period before any principal is paid and reduced. This is opposed to loans with interest-only payment features, balloon payment features and even negatively amortizing payment features.

BREAKING DOWN 'Amortized Loan'

The most common examples of an amortized loan are auto loans, home loans and personal loans from a bank for small projects or debt consolidation. Revolving debt and credit cards do not have the same features of an amortized loan as they do not have set payment amounts or a fixed loan amount.

Relationship Between Principal and Interest

Because interest is calculated based on the most recent ending balance of the loan, the interest portion of the loan payment decreases as payments are made. This is because any payment in excess of the interest amount contributes to reducing the principal, and this reduces the balance in which interest is calculated. As the interest portion of an amortization loan decreases, the principal portion of the payment increases. Therefore, interest and principal have an inverse relationship within the payments over the life of the amortized loan.

Calculations

There are a series of calculations regarding an amortized loan. First, the current balance of the loan is multiplied by the interest rate attributable for the current period to find the interest for the period. Annual interest rates may be divided by 12 to find a monthly rate. The interest for the period represents the portion of the payment attributable to interest. Therefore, subtracting the interest for the period from the total monthly payment results in the dollar amount of principal paid in the period.

The amount of principal paid in the period is applied to the outstanding balance of the loan. Therefore, the current balance of the loan minus the amount of principal paid in the period results in the new outstanding balance of the loan. This new outstanding balance is used to calculate the interest for the next period.

Amortization Table

The calculations of an amortized loan may be displayed in an amortization table. The table lists relevant balances and dollar amounts for each period. Each period is a row in the table, while the columns are typically current loan balance, total monthly payment, interest portion of payment, principal portion of payment and ending outstanding balance. The ending outstanding loan balance of one period becomes the current loan balance for the next.

RELATED TERMS
  1. Negatively Amortizing Loan

    A loan with a payment structure that allows for a scheduled payment ...
  2. Amortization Schedule

    A complete schedule of periodic blended loan payments, showing ...
  3. Negative Amortization Limit

    A provision in certain loan contracts that limits the amount ...
  4. Fully Amortizing Payment

    A periodic loan payment, part of which is principal and part ...
  5. Standing Loan

    A type of loan where payments are made of interest only. Repayment ...
  6. Cumulative Interest

    The sum of all interest payments made on a loan over a certain ...
Related Articles
  1. Personal Finance

    What is an Amortization Schedule?

    An amortization schedule is a table that shows the amounts of principal and interest that comprise each loan payment.
  2. Personal Finance

    Mortgage Amortization Strategies

    Should you get a 30-year mortgage? A 15-year one? Ways to decide which mortgage is the best fit.
  3. Personal Finance

    Simple Interest Loans: Do They Exist?

    Yes, they do. Here is what they are – and how to use them to your advantage.
  4. Personal Finance

    Understanding Term Loans

    A loan from a bank for a specific amount that has a specified repayment schedule and a floating interest rate.
  5. Personal Finance

    Interest-Only Mortgages: Home Free Or Homeless?

    These loans can be beneficial, but for many borrowers, they present a financial trap.
  6. Personal Finance

    Time To Consolidate Your Student Loans?

    Use these strategies to decide whether consolidating your student loans makes sense for you – and what to do next if it does.
  7. Investing

    4 Ways Simple Interest Is Used In Real Life

    Simple interest works in your favor when you're a borrower, but against you when you're an investor.
  8. Personal Finance

    How Interest Rates Work On A Mortgage

    A step-by-step explanation of the interest calculations, mortgage types, and how the loan is eventually "retired" – which means paid off.
  9. Investing

    Commercial Real Estate Loans

    Obtaining a commercial real estate loan is quite different from borrowing for residential real estate. Here's what to expect and how to get what you need.
RELATED FAQS
  1. Are student loans amortized?

    Student loans typically get paid back over time on a fixed payment, or amortized, schedule. Read Answer >>
  2. Which is better, a fixed or variable rate loan?

    A variable interest rate loan is a loan in which the interest rate charged on the outstanding balance varies as market interest ... Read Answer >>
  3. Why is more interest paid over the life of a loan when it is capitalized?

    Learn what it means to capitalize interest on a loan. Understand why more interest is paid over the life of a loan when it ... Read Answer >>
  4. How should you choose the amortization period for your mortgage?

    Read about key considerations that homeowners should take into account before choosing the amortization period for their ... Read Answer >>
Trading Center