A family of four with two young children sit on a cream-colored couch in a cozy living room.

5 Questions and Answers About Loan Amortization

05/29/2020

What is loan amortization? Fifth Third Bank has a complete list of the top 5 FAQs to help you understand the loan amortization process and benefits.

Most people know that when they get a fixed mortgage loan to buy a home, they will be required to make monthly payments for 30 years, or 15 years, or whatever term they have agreed to with their lender. But people might not understand exactly how those monthly payments will pay off their home loans, along with interest to the lender, over time.

That happens through a process called loan amortization, and understanding how it works will help you understand exactly how much you’re paying for your home—and how you might save money by paying it off faster.

What's Loan Amortization?

Amortization is the process of spreading out a loan into a series of fixed payments over time. The amount the borrower pays each month remains the same, but the payment is divided up differently each month, with different portions going to the principal, or loan amount, and to the lender to cover interest.

An amortized loan allows you to pay off some of the principal along with interest in each monthly payment. When you reach the final payment, the loan is completely paid off, including the price of the asset and all accompanying interest. So if you have a 30-year home mortgage loan, when you make the 360th monthly payment, your balance will be zero.

What Types of Loans are Amortized?

Any loan that includes interest and principal in every payment is amortized, and various types of loans work this way. Usually, home mortgage loans are amortized. Car loans and student loans are often amortized. Some personal loans are also structured with an amortization schedule, allowing the borrower to see exactly how each payment is divvied up between principal and interest.

What Does an Amortization Schedule Look Like?

An amortization schedule is a chart that shows how your payment is distributed among principal and interest, and how that ratio changes throughout the life of your loan. The amount applied to interest will usually be much larger during the early part of your repayment period and will decrease over time.

This sample amortization schedule shows how the payment is divided between interest and principal for the first year of payments for a purchase of $250,000 home with 20 percent down on a 15-year mortgage with an interest rate of 5 percent.

Month Monthly payment Balance Principal paid Interest paid Cumulative interest

1

$1,582

$199,252

$748

$833

$833

2

$1,582

$198,500

$751

$830

$1,664

3

$1,582

$197,746

$755

$827

$2,491

4

$1,582

$196,988

$758

$824

$3,315

5

$1,582

$196,227

$761

$821

$4,135

6

$1,582

$195,463

$764

$818

$4,953

7

$1,582

$194,696

$767

$814

$5,767

8

$1,582

$193,926

$770

$811

$6,579

9

$1,582

$193,152

$774

$808

$7,387

10

$1,582

$192,376

$777

$805

$8,191

11

$1,582

$191,596

$780

$802

$8,993

12

$1,582

$190,812

$783

$798

$9,791

To see the amortization breakdown for your home, use Fifth Third’s online mortgage calculator and click “amortization” underneath the chart.

How Are Amortized Loans Helpful for Borrowers?

Getting an amortized loan allows a borrower to pay off the loan principal a little at a time, rather than paying only interest for the first several years. By paying a little principal each month, you are able to build equity in your home or vehicle, even when you still have many years left to pay.

Amortized loans also make it easier to budget for your payments, since the payments will be the same each month. Even if you have an adjustable-rate mortgage, rate adjustments are usually only allowed once per year, so your amortization schedule won’t change more than once per year.

When you understand how a mortgage amortization schedule works, you’ll have a better idea of how much you’re actually paying for your home over time. And if you choose to make extra payments and pay the loan off early, you’ll see how that eliminates some of the interest you’d have to pay if you kept paying for the full life of the loan.

How Are Unamortized Loans Different from Amortized Loans?

Usually, unamortized loans require interest-only payments for most of the life of the loan, and then toward the end of the repayment period, the borrower must make a balloon payment that will pay off the principal.

Unamortized loans do not allow you to build equity in your home or automobile along the way, because you’re only making interest payments most of the time. However, unamortized loans do allow a borrower to make smaller payments (because they’re interest only). That can work well for some borrowers, especially if you expect to come into a large sum of money to pay off the principal later.

Share this Article