Loan Amortization

Loan Amortization

Amortization is the term for paying down the cost of an asset at a certain rate. In the real estate world, typically when we're referring to amortization we are referring to the rate at which we are repaying the principal on a loan back to the lender. Let's take a look at this graphically.

Example

Imagine that we have our loan amount and time, let's say this is 30 years. If a loan is fully amortizing, it is paid off down to zero at the end of the life of the loan. It starts out at whatever the loan amount is and a fully amortizing loan is paid completely off.

Full Amortization

The most common example of a fully amortizing loan would be your standard 30 year fixed rate home loan. You have an equal payment that goes every month for the entire life of the loan and at the very last payment the loan balance is zero.

Partial Amortization

Sometimes we have what's called a partially amortizing loan and that would be when the loan is paid down but not all the way. In the case of a partially amortizing loan, we end up with a balloon payment. Typically when you find a partially amortizing loan it is often because payments are amortized over say 25 or 30 years, but the term of the loan is shorter and we have a balloon payment say after maybe 10 or 15 years.

No Amortization (Interest-Only)

The next type of structure is no amortization. In other words, not paying any principal at all, we're simply paying interest only. The loan balance at the beginning of the loan never changes, it stays constant throughout the life of the loan because payments are only made to cover interest and not paying down any principal.

Negative Amortization

Finally, sometimes we run into what we call negative amortization. Typically negative amortization occurs when payments are not sufficient to cover even the interest that has accrued each month or each period and any unpaid interest is capitalized onto the balance, thereby increasing the loan amount and the loan balance over time.