
Loans And Amortization  Amortization
There are two types of amortization. One relates to the way certain business expenses are deducted, which we discussed in Section 2. The other relates to the way a loan is repaid, which we'll discuss here.
Amortization describes the paying off of debt in regular installments over a period of time. An amortized loan has scheduled periodic payments of both principal and interest. With a selfamortizing loan, the periodic payments consist of both principal and interest in an amount such that the loan will be paid off by the end of a scheduled term. Assuming the loan is a fixedrate loan, the amount of each payment and the breakdown of the principal and the interest that comprise each payment can be known in advance. If the loan is an adjustablerate loan, it can still be selfamortizing, but because the interest rate is subject to change, the amount and breakdown of each payment cannot be known in advance.
Borrowers who choose fully amortized loans are less likely to experience "payment shock" than borrowers who choose loans that 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 for the outstanding principal balance to be repaid. The shorter the remaining term, the larger the increase required in the periodic payments to amortize the loan over the remaining term.
With a fully amortizing loan, the principal balance decreases with each payment. With a negatively amortizing loan, the principal balance increases each month because the payments fail to cover the interest due. The unpaid interest, called "deferred interest," is added to the loan's principal, which ultimately causes the borrower to owe more money.
For example, consider a loan with an 8% annual interest rate, a remaining principal balance of $100,000, and a provision that allows the borrower to make $500 payments at a certain number of scheduled payment dates. The interest due on the loan at the next scheduled payment would be: 0.08 / 12 x 100,000 = $666.67. If the borrower makes a $500 payment, $166.67 in deferred interest ($666.67  $500) will be added to the principal balance of the loan for a total remaining principal balance of $100,166.67. The next month's interest charge would be based on this new principal balance amount, and the calculation would continue each month leading to increases in the loan's principal balance or negative amortization.
Negative amortization cannot continue indefinitely. At some point, the loan must start to amortize over its remaining term. Typically, negatively amortizing loans have scheduled dates when the payments are recalculated, so that the loan will amortize over its remaining term, or they have a negative amortization limit which states that when the principal balance of the loan reaches a certain contractual limit the payments will be recalculated.
With a nonamortizing loan, payments on the principal are not made, while interest payments or minimum payments are made regularly. As a result, the value of principal does not decrease at all over the life of the loan. The principal is then paid as a lump sum at the maturity of the loan. Examples of nonamortizing loan agreements are balloon mortgages and deferred interest programs.
An amortization schedule is a chart showing a complete breakdown of periodic blended loan payments. It shows the amount of principal and the amount of interest that comprise each payment so that the loan will be paid off at the end of its term. Early in the schedule, the majority of each periodic payment is interest. Later in the schedule, the majority of each periodic payment is put toward the principal.
If you know the term of a loan and the total periodic payment, an easy way to calculate an amortization schedule is to do the following: Starting in month one, multiply the loan balance by the periodic interest rate. This will be the interest amount of the first month's payment. Subtract that amount from the total payment, which will give you the principal amount.
To calculate the next month's interest and principal payments, subtract the principal payment made in month one from the loan balance, and then repeat the steps from above.
As an alternative, you can let a loan amortization calculator do the work for you.


Personal Finance
Simple Interest Loans: Do They Exist?
Yes, they do. Here is what they are â€“ and how to use them to your advantage. 
Economics
Understanding Term Loans
A loan from a bank for a specific amount that has a specified repayment schedule and a floating interest rate. 
Credit & Loans
Understanding the Mortgage Payment Structure
We explain the calculation and payment process as well as the amortization schedule of home loans. 
Credit & Loans
How Interest Rates Work On A Mortgage
A stepbystep explanation of the interest calculations, mortgage types, and how the loan is eventually "retired" â€“ which means paid off. 
Personal Finance
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. 
Credit & Loans
10 Ways to Manage Student Loan Debt
How to manage those pesky payments as you embark on adult life. 
Credit & Loans
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. 
Home & Auto
Choose Your Monthly Mortgage Payments
Exotic mortgages allow you to decide how much to pay. Find out how much they really cost. 
Economics
What Does Principal Mean?
For banks, principal refers to the amount due on a loan, and is used to calculate interest payments. 
Mutual Funds & ETFs
Financial Institutions: Stretched Too Thin?
Find out how to evaluate a firm's loan portfolio to determine its financial health.

Negatively Amortizing Loan
A loan with a payment structure that allows for a scheduled payment ... 
Amortized Loan
A loan with scheduled periodic payments of both principal and ... 
Fully Amortizing Payment
A periodic loan payment, part of which is principal and part ... 
Deferred Interest
The amount of interest that is added to the principal balance ... 
Amortization
1. The paying off of debt in regular installments over a period ... 
Negative Amortization
An increase in the principal balance of a loan caused by making ...

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 >> 
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 >> 
Why does the majority of my mortgage payment start out as interest and gradually ...
When you make a mortgage payment, the amount paid is a combination of an interest charge and principal repayment. Over the ... Read Answer >> 
What are the pros and cons of life insurance policy loans?
Find out the pros and cons of borrowing against your life insurance policy to help you decide if this loan type is the right ... Read Answer >> 
How does debt consolidation lower my monthly payments?
Find out how combining your debts into a single debt consolidation loan might actually lower the total amount you have to ... Read Answer >> 
When capitalizing interest, will interest accrue while you are in a deferment?
Learn what capitalized interest is. Understand why interest accrues while a person is in a deferment, based on capitalized ... Read Answer >>