Loan amortization
Amortization is the repayment of a loan. It is usually used in
conjunction with a time frame. For example, a 30 year loan term
amortizes over a 30 year time frame.
The longer the term is for a loan the slower it amortizes. This slower
amortization means a lower monthly payment. It can also mean more
interest paid out over the life of the loan.
A typical loan payment involves two components:
part of it is the interest payment,
and part of it paying off the principal
A constant payment on a 30 year fixed loan term amortizes each month
over a period of 360 months. This is normal amortization.
Amortization can also work in reverse. Minimum payment option loans,
such as 1% loans that you see advertised can give a borrower the option
to pay less than an interest-only payment (the minimum payment). An
interest-only payment keeps a loan the exact same size. It is not being
paid off. Ever penny over the interest-only level is used to pay off the
principal. If you pay less than the interest-only level, then you are
actually adding to the size of the loan. An increase in loan size is
known as negative amortization.
You will see 1% loans marketed under such names as:
minimum option ARMs
minimum payment loans
pick a payment loans
Lenders have been experimenting with longer and longer loan terms for
mortgages. First 40 year loan terms were offered. Now some lenders are
offering 50 year loans.
An "amortization schedule," in general, is a record of loan or
mortgage payments. This record includes the payment number, date,
amount, breakdown of principal and interest, and the remaining balance
owed after the payment. An amortizing loan's periodic repayments contain
an amount designated for the reduction of the principal, so that the
balance will eventually be reduced to zero. The time necessary for the
balance to reach zero is calculated in an amortization schedule.
What is Fixed Rate Amortizing Loans?
The monthly payments for interest and principal remain consistent and
never change in fixed rates. The monthly payments will typically be
stable even if property taxes and homeowners insurance increase. In a
fixed rate-amortizing loan, the interest rate remains fixed for the life
of the loan. The monthly payments remain level for the life of the loan
and are prearranged to pay off the loan at the end of the loan term. An
example of a fixed rate loan is a 30-year mortgage that takes 22.5 years
of level payments to pay half of the original loan amount.
Importance of Principal and Interest in Amortization Loans
The method in which the principal and interest are applied is very
useful to understanding amortization loans. For example, in an
amortization schedule, the majority of the payment applies to interest
early in the loan, with a small amount applied to paying off the
principal. As the loan matures and there is less principal remaining to
be repaid, more of the payment is applied to repaying the principal
since there is less interest owed to the lender. Only a small amount of
interest is paid by the monthly payment by the end of the loan, and most
of it applies to the principal.