Loan amortization is the process through which lenders schedule loan payments into equal payments over the life of your loan. Each installment, or payment, includes interest costs and a portion of the loan principal.

Most lenders offer an amortization calculator or table to help borrowers determine their monthly payments. However, those mathematicians among us can calculate the numbers using basic information such as the loan term (number of months you'll be paying the loan), loan amount, and the interest rate on your loan.

However, the tables and automated calculators can help determine much more than your monthly payments through loan amortization. They can also be used to determine how much you can save by making additional loan payments and how much interest you pay each year for your taxes.

What is Loan Amortization?

Loan amortization refers to the process of paying off a debt over time with equal payments. These payments are typically made regularly, such as monthly or quarterly, and they are designed to gradually reduce the loan balance until it is completely paid off.

In an amortized loan, each payment comprises both principal and interest. The interest is the cost of borrowing the money, while the principal is the amount borrowed. Initially, most of the payment goes towards paying off the interest, while a smaller portion is applied to the principal. Over time, as the loan balance decreases, more of the payment goes towards reducing the principal.

Loan amortization schedules provide a detailed breakdown of each payment, showing the amount of interest and principal being paid. These schedules can help borrowers understand how much they pay in interest and how long it will take to pay off the loan.

Types of Amortized Loans

While many people think of loan amortization only about home loans, the truth is that practically any fixed-rate loan can be (and likely is) amortized. That includes various loans such as:

• Auto loans
• Boat loans
• Fixed-rate mortgages
• Home equity loans
• Motorcycle loans
• Personal loans
• RV loans
• Student loans

The reason is simple, it is the easiest way to balance the dynamics of interest and principal when determining loan payment amounts. The loan amortization schedule allows borrowers to understand how much interest and principal they pay with each payment and the balance remaining after each charge. You can also use this table or an amortization calculator to determine how much money you can save by making extra payments. It is a handy and informative tool for borrowers to see how their money works. This helps borrowers determine how they can best invest in their financial futures.

Types of Loan Amortization

Most people are unaware that even among amortized loans, there are two different types of loan amortization. A fully amortized loan is what most people associate with the loan amortization process. However, it is not the only option available. Understanding the differences between the two can help you make fully informed choices about the type of loan that best meets your short and long-term financial needs.

Full Loan Amortization

A fully amortized loan creates a situation in which borrowers have equal payments for every payment over the life of the loan. You can still make additional payments that may affect the number of payments and the amount of each payment, but those will also be accounted for in the scheduling process for the future.

Partial

Partial loan amortization is a method of paying off a loan that involves making regular payments that are insufficient to fully amortize the loan over its term. Instead, the payments are designed to cover the interest and a portion of the principal, but not enough to ultimately pay off the loan by the end of its term.

Under a partial loan amortization plan, the remaining balance of the loan is typically due in a final lump sum payment, known as a balloon payment. The balloon payment generally is larger than the regular payments made over the life of the loan.

Partial loan amortization can be helpful when the borrower expects to have a large sum of money available at the end of the loan term, such as from the sale of an asset or the receipt of a bonus or inheritance. It can also be used to reduce the monthly payments on a loan, making it more affordable in the short term.

It's worth noting that partial loan amortization can be riskier than fully amortized loans, as a larger final payment is due at the end of the loan term. Borrowers should consider their balloon payment ability before choosing a partial loan amortization plan.

Benefits of Loan Amortization

Loan amortization provides a schedule of payments that borrowers can make to repay their loans. Whether the loan is wholly or partially amortized offers unique benefits to specific types of borrowers. For instance, people who intend to purchase properties for short periods and then resell the home, like house "flippers." For those who intend to live in their homes long-term, the balloon payment at the end of the term can be a challenge, and failing to make that payment will result in defaulting on the loan.

The fully amortized loan, on the other hand, offers a regular monthly payment for the duration of the loan, allows borrowers to maximize tax benefits by quickly determining how much interest they pay on their mortgages each year, and provides the tools they need to determine ways to save better on their purchases by making extra payments along the way.

Tips for Managing Loan Amortizations

The best tip for managing loan amortization is to make sure you understand what type of amortization loan you're getting from the start and fully understand the potential consequences of falling behind or failing to repay your loan according to its terms.