What is Amortization? A Guide to Loan Repayment Schedules

I’ll admit the first time I heard the word “amortization” I thought it sounded like an immortality spell cast by a character from Harry Potter. Can’t you just picture Voldemort shouting “AMORTIZATE!”? Unfortunately, although I’d love to teach you about death-defying magic, I’m here to discuss something else.

Amortization is the process by which periodic payments repay an installment loan. 

This method involves dividing each periodic (typically monthly) premium between interest and principal so that you pay off the entire outstanding amount over time. 

While it’s not quite as exciting as magic, amortization enables you to plan your finances because you understand exactly how much you owe — both in payments and over the life of the loan. In this article, I’ll explain the concept of amortization, its basic principles, its payment splitting, and its various types and schedules.

Amortization may sound fancy, but it is little more than a plain old way to repay a loan. I’m going to walk you through the nuts and bolts of how it works and why you should care.

Principal and Interest Breakdown

With an amortized loan, all the payments you make are split, with some portion going toward the interest and the rest cutting into the principal. At the start, most of the money pays interest. In the fullness of time, more and more of your payments go to cutting down the principal, which shrinks little by little until your balance is gone.

That’s because as your principal gets smaller, there’s less interest to pay, which means more of your hard-earned dollars attack the principal. Amortization gives you an idea of how your debt will shrink over time. It lets you decide whether to throw extra money in, knocking down the interest even faster.

Amortization Schedules

An amortization schedule is like a road map — it shows how long you’ll be paying down a loan and breaks each payment into interest and principal portions. It also spells out how much the loan balance will shrink when you toss in your payments.

Unlike your credit cards, in which you can borrow and pay back as you please, an amortization schedule tells you precisely what your payments are doing to your debt. You can see, clear as day, how much you’ll owe over time and how much interest you’ll have to cough up by the time the loan’s paid off.

Types of Amortizations

The various types of amortizations regulate how you’re going to pay off your loan and how much extra interest you’ll end up handing out.

• Full amortization: Full amortization is where your regular payments knock out the whole loan by the end of the term.
• Partial amortization: Partial amortization is where there’s still a chunk of principal left at the end. You’ll pay that remnant with a big old balloon payment. 
• Negative amortization: There’s negative amortization, where the payments don’t even cover interest, and the principal gets bigger.
• Interest-only amortization: Finally, there’s interest-only amortization, where you’re just paying the interest and don’t touch the principal.

These choices help you pick the loan setup that’ll work best for you and your wallet.

Amortization vs. Revolving Debt

When you set amortized loans up against revolving debt, it’s plain to see how each one divides up your money in its own particular way. Amortized loans, such as mortgages and car loans, come with a set schedule for paying them off. Revolving debt, on the other hand, lets you borrow and pay back at whim (as long as you make the minimum payments). That’s the way credit cards and lines of credit work.

With amortized loans, you know exactly how much you’re paying each month, how much goes toward interest, and what goes toward principal. The schedule makes it really easy to plan ahead. Your interest on revolving debt may sneak up on you, depending on how much you spend and how you pay it back.

Sure, revolving debt gives you more wiggle room, but that wiggle can end up costing you a pretty penny in interest if you aren’t careful. I dare say wiggling has caused all sorts of problems since the dawn of humanity.

Comparing these two kinds of debt is something worth doing if you want to get a grip on how they affect your long-term wealth. One gives you structure, and the other gives you freedom — but that freedom can come with a hefty price tag if you don’t keep an eye on it.

Many types of loans depend on amortization, which lets you pay slowly and surely. In a repayment schedule, amortization allows you to whittle away at both the principal and the interest every month. You’ll find amortization in some of the most common loans around – mortgages, car loans, and student loans.

Mortgages

Amortization is how you pay off the principal and interest bit by bit over the life of a home loan. In a period typically spanning between 15 and 30 years, a part of every monthly payment goes to pay interest and knock down some of the principal amount.

At first, most of your money’s going toward interest, but after some time passes and the principal shrinks, so does the interest. Pretty soon, more of your cash is going toward the principal itself. All this makes things predictable by helping you plan your future finances and stick to a budget.

One of the beauties of mortgage amortization is that your monthly payment remains constant for the life of the loan. Sure, property taxes and insurance may jiggle your payment a bit, but the mortgage payment doesn’t change. 

Understanding your amortization schedule keeps you in the driver’s seat. You will see that as the principal balance falls, you will be paying less in total interest, which is what makes a mortgage such an affordable way to own a home. 

Equity is the current value of your home minus your mortgage balance. With every payment, you’re building equity in your property, making it more and more yours. 

Auto Loans

Just like mortgages, car loan amortization is all about making regular payments that knock out both the principal and interest. Now, car loans don’t drag on as long — usually three to eight years — which means you must repay the loan much sooner than a debt stretched out like a mortgage.

Car loan amortization affects your wallet based on the price of your new shiny set of wheels, the interest rate, your down payment, and how many payments you’re looking at. The shorter the term, the bigger your payments each month, but the less it’ll cost you in interest in the long run. Stretch the payments out longer and they’ll be smaller, but you’ll be forking over a whole lot more in interest.

Wrapping your head around these trade-offs will help you decide which loan terms will fit your situation the best. If you’re on time with your payments, you will build a solid credit history that’ll set you up nicely the next time you need a loan.

Student Loans

Student loan amortization lasts a lot longer than a hot summer day, anywhere from 10 to 30 years. That’s enough time for the sun to rotate 128 billion miles around the black hole at the center of the Milky Way! The monthly payments are set up so that by the time you’re done, you will have cleared the whole amount.

If you have a federal loan, the government will let you defer payments until after you finish school, allowing you some time to catch your breath before the real rodeo begins.

The government offers programs to let you off the hook for part of your loan if you take on certain jobs, like teaching in a low-income school district. That sounds like a win-win to me!

Federal loans offer income-driven plans that customize your payments each year, like a tailor fitting a suit, depending on how much income you bring in and how many mouths you have to feed. That makes life a heck of a lot easier.

Understand your repayment options and how each will hit your wallet to help manage your student debt and get your feet back on solid ground after school.

Amortization has a boatload of advantages for those who seek to take control of their finances. The result is a predictable schedule with the principal tumbling down like dominoes over time. It’s very easy to plan your budget that way. You can even save yourself a pretty penny in interest if you throw in some extra payments.

Predictable Financial Planning

Amortization is really handy when it comes to planning your money, thanks to your fixed monthly payments, which are as predictable as clockwork.

Among the key advantages are:

• Budgeting Ease: Those fixed monthly payments make household budgeting comparatively easy.
• Debt Reduction: Each payment takes a bite out of the principal to help whittle down your debt little by little.
• Financial Stability: Predictable payments give you a firm grip on your finances, keeping you from getting hit by surprises.
• Interest Savings: Since a portion of your payments hacks at the loan principal, you’ll pay less interest over time, a real savings over the life of the loan.
• Credit Building: On-time payments build credit scores and give you more opportunities for future borrowing.
• Peace of Mind: You know how much you owe every month, so your payments won’t nag on your nerves or burn a hole in your wallet. Can you say the same about your kids?
• Long-term Planning: Fixed payments allow you to plan a better strategy for your future. 

The predictability of an amortized loan surely makes wrangling your financial resources easier.

Can Reduce Interest With Extra Payments

Putting extra money into a loan payment is like throwing more logs on the fire — you’re going to burn through your debt quicker and save a pile of money in interest.

When you pay more than the bare minimum toward the principal, you’re basically knocking it down faster, which means there’s less principal left to generate interest. That ends up lowering the total cost of your loan, plain and simple.

This trick really works with long-term loans, such as mortgages, because even a few extra bucks now and then can save you thousands in interest down the road.

The added payments also mean you’ll be free from your debt sooner — much like reaching the end of a long hike a little sooner, one of life’s delights. But this approach isn’t for the weak willed. It’s going to take some good old-fashioned discipline and sticking to a plan to keep making those extra payments month after month.

If you’re trying to cut costs and reach financial stability much faster, then extra payments are worth their weight in gold. You won’t be saving on interest only, but you’ll pay down that loan quicker than an ice cream cone melting in summer. Knowing how that extra payment fits into your amortization schedule gives you the moral fiber to make smart decisions about your debt and keep your lenders quiet.

Amortization lays a straight trail to get rid of the debt, showing how much goes to the principal and interest with each payment. You should feel mighty good watching that balance deflate month after month, like whittling on a stick a little at a time.

With fixed payments, you won’t need to worry about any surprises jumping out at you. You’ll be able to plan your budget with less stress, knowing exactly where your money’s going. You’ll be guiding your financial unicorn toward that pot of gold at the end of the rainbow!