What is a Fully Amortizing Payment
Fully amortizing payment refers to a periodic loan payment where, if the borrower makes payments according to the loan's amortization schedule, the loan is fully paid off by the end of its set term. If the loan is a fixed-rate loan, each fully amortizing payment is an equal dollar amount. If the loan is an adjustable-rate loan, the fully amortizing payment changes as the interest rate on the loan changes.
BREAKING DOWN Fully Amortizing Payment
To illustrate a fully amortizing payment, imagine someone takes out a 30-year fixed-rate mortgage with a 4.5% interest rate, and his monthly payments are $1,266.71. At the beginning of the loan's life, the majority of these payments are devoted to interest and just a small part to the loan's principal, but near the end of the loan's term, the majority of each payment covers principal and only a small portion is allocated to interest. Because these payments are fully amortizing, if the borrower makes them each month, he pays off the loan by the end of its term.
Fully Amortizing Payments Versus Interest-Only Payments
In contrast to making fully amortizing payments, if a borrower is making interest-only payments, he is not on schedule to pay the loan off by the end of its term. On any loan that allows the borrower to make payments that are less than the fully amortizing payment early in the life of the loan, fully amortizing payments later in the life of the loan are significantly higher than the loan's initial payments.
To illustrate, imagine someone takes out a $250,000 mortgage with a 30-year term and a 4.5% interest rate. However, rather than being fixed, the interest rate is adjustable, and the lender only assures the 4.5% rate for the first five years of the loan. After that point, it adjusts automatically.
If the borrower were making fully amortizing payments, he would pay $1,266.71, as indicated in the above example, and that amount would simply increase or decrease when the loan's interest rate adjusts. However, if the loan is structured so the borrower only pays interest payments for the first five years, his monthly payments are only $937.50 during that time, but they are not fully amortizing. As a result, after the introductory interest rate expires, his payments may increase up to $1,949.04. By taking non-fully amortizing payments early in the life of the loan, the borrower essentially commits to making larger fully amortizing payments later in the loan's term.
Other Types of Loan Payments
In some cases, borrowers may choose to make fully amortizing payments or other types of payments on their loans. In particular, if a borrower takes out a payment option ARM, he receives four different monthly payment options: a 30-year fully amortizing payment, a 15-year fully amortizing payment, an interest-only payment, and a minimum payment. He must pay at least the minimum, but if he wants to stay on track to have the loan paid off in 15 or 30 years, he must make the corresponding fully amortizing payment.