What is loan amortization?
When you take out a large loan, often something like a car loan or a home loan, paying that loan back can take a significant amount of time. Home loans, or mortgages, can take 15-30 years to pay back, and for larger loans, understanding loan amortization is important.
Loan amortization is the act of making fixed-rate payments that reduce the amount of the loan you owe, while also paying the interest that is charged by the borrower. Your monthly payments will stay the same month after month, but over time, those payments will be split between principal and interest amounts differently. Interest payments start at a high point and reduce throughout the life of the loan. Keep in mind these two important terms:
- Principal: this is the amount you borrowed. For example, you have a $300,000 home loan, the principal amount is $300,000.
- Interest: this is the rate that your lender is charging you to borrow money. It is often shown as a percentage, such as 4%.
How do I use the loan amortization calculator?
Instead of trying to build your own amortization schedule, simply plug your details of your loan to the loan amortization calculator above.
With the total loan amount, the number of years the loan will be active, and the assigned interest rate, you’ll be able to get a custom amortization schedule in the Amortization tab below it.
What loans are amortized?
Many different types of loans can be amortized. Usually, the larger the loan, the higher chances are that you’ll be dealing with loan amortization. Loan amortization is commonly used in the following types of loans:
· Auto loans
· Student loans
· Home equity loans
· Personal loans
· Fixed-rate mortgages
How do I calculate loan amortization?
If you want to make your own loan amortization schedule, you’ll first need to calculate the monthly payment amount, using the below formula:
PMT = payment amount each period
LA = total loan amount
i = interest rate in decimal form
n = number of loan payments
Next, you’ll need to calculate the interest payment for each period. This part is simple.
P = principal remaining
i = interest rate in decimal form
Once you know the interest payment each period, you simply subtract that amount from the monthly payment, and you’ll get your principal amount each month. The formula is iterative, and the interest and principal amounts shift every month, though the monthly payment never changes. Because of the nature of this repayment plan, that’s why you see loan amortization schedules in table form.
How does loan amortization work?
Since you need to pay down the principal and pay back the interest fees attached to your loan, each monthly payment will be split between the two. When the loan first starts, a larger portion of your payment will go towards interest, but as it matures, your monthly payment will chip away at bigger chunks of the principal amount.
The amount you pay each month will not change, but the way it pays off the principal or interest amounts will. If you pay above the required monthly payment, ask your lender to apply the excess to the principal amount to help work through your loan more quickly and reduce the amount of interest you pay in the long term.
How do I read a loan amortization schedule?
When you take a look at a loan amortization schedule for the first time, all the rows and columns can feel overwhelming, but once you dive in, it’ll make sense quickly. There might be some slight variations in tables, but largely, they follow the same setup.
First, you’ll have two columns telling you what month you are on and how many months are left in the loan. These months are what decide how many rows are in the schedule. As you move across the table, you’ll see the total value left to be repaid, the payment amount due (which does not change), and the amount of the monthly payment that is going towards the principal.
Notice that the principal column goes up slightly each month. This is because the amount you pay will address interest more heavily at first, then slowly pay off larger principal amounts as the loan matures.
What’s the difference between amortized loans and unamortized loans?
Amortized loans spread the principal payments throughout the life of the loan, splitting each monthly payment between the principal amount and interest fees. This usually means that monthly payments on amortized loans are a bit higher than on unamortized loans.
Unamortized loans only require borrowers to make interest payments throughout the life of the loan, meaning you are not required to pay down the principal amount each month (though, it’s probably unwise to do this). Monthly payments are often lower, but you could get stuck with a large sum to pay off once the loan fully matures, this is called a balloon payment.