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What is an amortizing loan?
An amortizing loan is a type of debt that requires regular monthly payments. Each month, a portion of the payment goes toward the loan’s principal and part of it goes toward interest.
Also known as an installment loan, fully amortized loans have equal monthly payments. Partially amortized loans also have payment installments, but either at the beginning or at the end of the loan, a balloon payment is made.
Over time, the balance of an amortized loan decreases. A borrower can monitor the progress of paying off his or her loan’s balance by using an amortization schedule.
An amortization schedule is also a helpful visual representation that depicts exactly how much of each month’s payment goes toward interest and how much is applied to principal reduction.
Before any regular monthly payment is applied to reducing the loan’s principal, the borrower must first pay a portion of the interest owed on the loan.
To calculate the amount of interest owed, the lender will take the current loan balance and multiple it by the applicable interest rate. Then, the lender subtracts the amount of interest owed from the monthly payment to determine how much of the payment goes toward principal.
As the balance of the loan decreases, the portion of your payment that is applied to interest payment also decreases, while the amount that pays down the loan’s principal increases.
Interest-only loans, loans with a balloon payment, and loans that permit negative amortization are not amortizing loans.
Amortizing loan example
Hal and Barb borrowed $100,000 to buy a condominium in a suburb of Cleveland. They got an amortizing loan with an interest rate of 5 percent.
In the first month of the loan, the part of the payment that was applied to loan principal was $120.15, while the amount applied to interest was $416.67.
By month 12, the payment portion that was going toward paying off principal was $125.78, while the amount applied to interest had fallen to $411.04.
Do you have an amortizing loan? Monitor your amortization with an amortization schedule.