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What is an Amortized Loan?
Tricia Christensen
Tricia Christensen
An amortized loan is a loan where payments are the same amount each month. Each payment pays some of the interest on the loan and some of the principal, or amount borrowed. This type of loan can be total, meaning the payments will stay the same until the set period when the loan is paid off. Alternately partially amortized loans mean that at the end of the set payment period, a large additional payment, called a balloon payment is then due.
Generally an auto loan is likely to be an amortized loan. Especially during the early months of the loan, most of the payment will likely go toward interest. Very little of the early payments will actually pay off the principal, due to the fact that the loan charges all interest upfront. So with any loan of this type, gradually payment to principal increases and interest payment drops, even though the payment amount is the same.
The disadvantage of this type of loan in its first few years is that the percentage of property one actually owns can be very small. In an amortized loan for a vehicle, there is usually a point where the resale value of the car is much lower than the actual amount one would owe on the car if paid off immediately.
This upside down effect occurs because one has spent so little on actual principal amounts and so much on interest. There is usually a pay-off amount that is less than the total amount due on the loan. This may not correspond to the actual value of the car.
If one looks at a home amortized loan, one would see the same effect if house values dropped. For example, in a 15 year 100,000 US dollar (USD) amortized loan at 7% interest, the payment is close to 900 USD per month. Principal paid during the first year ranges from about 300-400 USD, per monthly payment. A larger amount of the payment, about 500-600 USD, pays the interest on the loan.
At the end of the first year of this amortized loan, one might have 3600-4200 USD of principal paid. If house values drop 10,000 USD in that year and one must resell the house, one would do so at a loss, affecting the amount of any down payment one might receive back. Even two or three years into payments, declining real estate values could mean that selling the home could result in a total loss of one’s initial down payment.
One can generally gain more ownership of a property by paying additional amounts to the principal of the loan. Usually one must first find out if the lending agency will allow extra payments to the principal. Further, one should make sure that payments to the principal are clearly marked and are credited as such by the bank or loan company. Sometimes making an additional payment on an amortized loan is viewed as making an early start on one’s next scheduled payment. Be certain to check that the bank is actually crediting these payments “to the principal.”
Tricia Christensen
Tricia has a Literature degree from Sonoma State University and has been a frequent WiseGEEK contributor for many years. She is especially passionate about reading and writing, although her other interests include medicine, art, film, history, politics, ethics, and religion. Tricia lives in Northern California and is currently working on her first novel.
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Tricia Christensen
Tricia has a Literature degree from Sonoma State University and has been a frequent WiseGEEK contributor for many years. She is especially passionate about reading and writing, although her other interests include medicine, art, film, history, politics, ethics, and religion. Tricia lives in Northern California and is currently working on her first novel.
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![An amortized loan is a loan where payments are the same amount each month.]()
By: GhostAn amortized loan is a loan where payments are the same amount each month. -
![A payment plan can be especially effective for lengthy loan paybacks like those found on mortgage agreements.]()
By: itsallgoodA payment plan can be especially effective for lengthy loan paybacks like those found on mortgage agreements.
Discussion Comments
Amortized home loans are keeping Americans broke. It is a secret to most Americans that the banks are cleaning their pockets. Most people believe that they are getting simple interest loans when in reality on a 30 year home loan, but even after six years, they will be paying .70 return to the bank for use of that money. And most Americans live less than 10 years in their homes.
An amortized loan is an archaic method that needs to be changed for the current environment.
This loan was implemented in the 1950s when the population base stayed in their home until retirement, because they were able to retire from their jobs after 30 years. Hence, the 30 year mortgage. But, if you look at how the loan is set up it really gets around usury laws. It takes about 17-18 years before one starts paying more into the principal. And, it is about a 50.2 percent to 49.8 percent, principal to interest respectively.
I am not sure how you got $300-$400 goes towards principal in the first year, but that is off by quite a bit. The norm is about 10-20 percent goes toward principal the first several years. This is a joke of a method, but it is what we have.
I think that you really need to understand what you can afford to pay and how long it will take you to get there.
The loan calculator amortization table might help you decide if you will go into a 15 year fixed or a 30 year fixed loan.
Financial experts all agree that the 15 year fixed rate mortgage is the best mortgage product out there because the interest rate is lower and you pay off your home in half the time.
Most people, however, do go with the thirty year fixed rate mortgage because the payments are almost half of the 15 year mortgage loans.
Also, with a 30 year loan you could make extra payments if you want, and when you can’t you don’t have to but with a 15 year loan you don’t have that flexibility because the amoritized loan schedule is shortened.
I agree with you. I currently have a home equity line that I am paying on and the payments are really low because it is variable rate interest only line.
I always make extra payment every month and I have paid an additional $75,000 over a two years time. I am trying to eliminate this loan as quickly as possible.
If I waited until the ten years were up, the remaining balance would be converted to a fixed loan in which I would have amortized loan payments for the next ten years, but if I don’t make significant payments, I would have paid ten years of interest only and then have to start the loan all over again at that point.
I agree that loan amortization calculators are a good idea to look at when you are buying a house.
An amortized mortgage loan does make you pay more interest than principle initially but you can make extra payments to get to the principle faster.
For example, if you want to pay off your mortgage faster, you can look at an amortized loan calculator on Bankrate.
There you can input the interest rate along with the amount you are financing along with any additional payments. It will offer you a new payoff date that you can print and put on your refrigerator in order to stay motivated.
They say that one extra mortgage payment shaves off about eight years off the loan for a thirty year fixed rate loan.
It is always good to make a realistic budget and view a loan amortization table in order to see if your payoff date is realistic.
I paid off my first loan this way, by making double payments and it does feel good. The sense of security that you feel from owning your home free and clear is like no other feeling in the world.
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