What is Loan Amortization?

Before taking out a loan, it’s important to understand how your payments are structured over time. Loan amortization is the process of breaking down a loan into fixed, regular payments that cover both the amount borrowed (the principal) and interest. This structured repayment plan ensures that the loan is fully paid off by the end of the term.

Banks, credit unions and online lenders use amortization for many types of fixed-rate loans, helping borrowers manage repayment with predictable monthly payments. Let’s take a closer look at how loan amortization works so you know what to expect when borrowing.

What is an amortized loan?

To put it simply, the Consumer Financial Protection Bureau (CFPB) defines an amortized loan as a type of installment loan with a set number of fixed payments –– usually for the same amount every month ¹. If you make at least the minimum monthly payment, you can repay a fully amortized loan by the end of the payment term. The amount you pay stays the same. It’s just distributed differently as you pay down your balance.

To make it easier to understand, amortized loan payments are made up of two parts:

• Interest: Part of your payment goes toward paying the interest, which is the cost or fee for borrowing the money.
• Principal: The remaining portion goes toward paying down the principal, which is the original amount you borrowed.

At the beginning of your repayment term, a larger portion of your payment typically goes toward interest, while a smaller portion is applied to the principal. Often, the interest payment can even be higher than the principal payment.

As you continue making payments, the interest portion of your payment gradually decreases, and more of your payment goes toward reducing the principal. By the end of your loan term, most of each payment is applied to the principal, helping you pay off the remaining balance.

How loan amortization works

Lenders use amortization to break big loans down into a payment schedule that ensures full repayment by the end of the term. Your loan term, interest rate and the amount you’ve borrowed determine what that payment schedule looks like, and based on this, will determine how your loan is amortized. Let’s dive into the basics of how a loan’s amortization is determined.

In addition to external factors like the cost of money and state lending laws, your lender determines your interest rate based on the information you provided on your application. Each lender has its own policies, but some of the factors that are unique to you that might affect your interest rate include your credit score, payment history and income. Over time, your loan balance accrues interest according to that rate.

Understanding how interest works can help you manage your loan payments and avoid unnecessary costs. Here’s a breakdown of two common types:

Simple Interest Loans

• With a simple interest loan , your payment usually goes toward any fees first, then interest, and the rest is applied to your principal balance.
• Interest is based on your most recent loan balance, so as you make payments, the amount of interest you owe decreases.
• Making extra payments toward the principal can reduce the total interest you pay over the life of the loan.
• Over time, more of your payment goes toward the principal rather than interest, reducing your total loan balance.

Precomputed Loans

• Precomputed interest is calculated in advance for the entire loan term and added to the principal balance.
• Your total repayment amount is determined upfront, with a fixed schedule of equal payments.
• Unlike simple interest loans, making extra payments won’t reduce the total interest you owe.
• These loans assume you’ll make payments on time each month. If you fall behind, late fees or other penalties may be added, increasing your total cost.

Regardless of the loan type, you will always pay more than the amount borrowed due to interest. Knowing how your loan is structured can help you plan your payments and avoid paying more than necessary.

If you’re wondering how your payments on an amortized loan will break down, you could plug the information into an amortization calculator or use a spreadsheet to generate a loan amortization table.

What is a loan amortization table?

A loan amortization table is a month-by-month breakdown of all the payments you’ll make throughout the loan term. You can ask your lender for an amortization break down for your prospective loan amount
Amortization is typically influenced by some of the following factors:

• Basic loan information – your total loan amount, term and interest rate.
• Loan payment frequency – how often you make payments, usually monthly.
• Total minimum payment – the total minimum payment you owe each month.
• Additional payment – any amount you pay over the minimum.
• Starting balance – the total amount of your loan you owe at the beginning of the repayment period.
• Interest payment – the portion of each payment that goes toward interest.
• Principal payment – the portion of each payment that goes toward your loan’s principal.
• Ending balance – the remaining amount you still owe on your loan at any time during the repayment period.

Examples of amortized loans

• Many installment loans are amortized, including car or motorcycle loans.
• Personal loans, including loans for weddings, funerals, vacations, emergencies and more.
• Certain types of mortgages.
• Student loans, though repayment plans may differ.

Keep in mind that income-based repayment plans may impact student loan amortization. If you have questions, going over your loan amortization table with your lender could help you avoid any surprises down the road.

Pros and cons of amortized loans

Amortized loans are more predictable than many other types of financing, but they’re not without disadvantages. Here are a few pros and cons to keep in mind:

Pros

• Amortized loans don’t involve any guesswork, which makes budgeting for payments easier because your payment amount remains the same each month.
• You don’t have to worry about a balloon payment –– a large, lump-sum payment due at the end of the loan term.
• Paying more than your regular minimum payment can reduce your principal, which lowers the interest that accrues and the total amount you’ll pay over the life of the loan.

Cons

• While amortized loans offer fixed, predictable payments, making only the minimum required regular payment means you’ll pay more interest over time compared to paying extra toward the principal.

Know what to expect with amortization

Loan amortization can help you tackle a big purchase like a home repair, a car or a medical bill –– and pay for it over time instead of all at once. Before you take on a mortgage or an installment loan, be sure to consider your other monthly expenses, check the amortization table and ask your lender questions before signing, so you’ll know exactly what the future brings. When you’re prepared to make predictable loan payments, it’s easier to stay within your budget and make the best money moves for you and your family.

Source:
1,2 [https://www.consumerfinance.gov/consumer-tools/mortgages/answers/key-terms/](https://www.consumerfinance.gov/consumer-tools/mortgages/answers/key-terms/)