How Amortization Works and Other Things You Need to Know

loan amortization paper plan lying worktable

Most people when asked about their ultimate dream, the first thing that comes to mind is to be independent — being independent for the majority of people means having a stable lifestyle, being able to secure properties, and finding a path to a debt-free life.

That definitely sounds ideal and almost perfect, until reality hits you. Unless you were born with a silver spoon in your mouth, owning a property is challenging to say the least.

Well, good news is that we are now living in a time when processing loans are attainable and more affordable than before. Thanks to the smart bankers who thought of easing the burden of paying loan balance — which gave birth to what we now know as amortization.

The Term “Amortization” Refers to Two Situations:

1. Amortization is used in the process of paying off debt through regular principal and interest payments over time. An amortization schedule is used to reduce the current balance on a loan, for example, a mortgage or car loan, through installment payments.

2. Amortization can also refer to the spreading out of capital expenses related to intangible assets over a specific duration—usually over the asset’s useful life—for accounting and tax purposes.

In other definition, amortization is a general reduction of your mortgage overtime.

If you’ve already inquired about home loans, chances are the banking partners and brokers have already explained the basics of amortization. To make it even easier to understand, here are collected explanations and related articles from various experts. Read on and find answers about loan, interest, mortgage and how amortization works.

Understanding Mortgage Amortization

The word ‘amortization’ was derived from the same Old French root as “mortgage” which means to “kill down” or “extinguish” the debt overtime.

Years before the discovery of amortization, loans were a pretty serious burden for the lender — they had a 5-year-time-span, huge monthly payment, loans were intended specifically and only for building construction and government agencies were not involved — which made any loan unsecure back then.

Amortization is the process of stretching out a loan into a series of fixed loan payments. This way you can pay both the principle of the mortgage amortization loan and the interest loan without shelling out huge amounts of money to settle the loan in one go.

It can vary from one user experience to another but more often than not, the first part of your payment goes toward paying interest balance. On the other hand, the latter part of your payment goes to the principal balance.

Amortization is a precise calculation of both principal and interest payment so that the lender can pay off the loan on a set period of time, typically 15 to 30 year mortgage — bankers and brokers refer to it as the term of the loan.

If you’re after a home loan, amortization can make it more affordable by having a fixed-rate mortgage payment method that you could look forward to every month.

Quick Story

Sounds harmless right? If you’re still skeptical about the idea of amortization and the mortgage payment process, here’s a quick story: mortgage amortizations weren’t always the 30 year fixed rate and low interest people enjoy today.

The first mortgages that were issued around 1930’s had only 5-7 years short-term loans — that only covered 50% of the total property value. Worse part is, most of the mortgages payments only covered the interest of the loan, which resulted in lenders paying up a huge “balloon payment” at the term finale in order to complete the remaining principal balance.

Balloon loans is a type of loan (can be mortgages, personal loans, car loan, or student loan) that requires the lender to pay off the remaining loan amount in full.

All loans (whether personal loans, student loans, or car loans) usually have three parts. These are the principal, interests, and time span.

  • Principal – payment goes toward the actual asset
  • Total Interest – think of it as an “authorization fee” that allows people to use the money from banks
  • Time span – typically loan is paid over 15 to 30 years

How Amortization Schedules Works

Mortgage amortization schedule acts as a reflection of the total monthly breakdown of interest and principal repayment in an amortized loan.

Note that even though the monthly payments will be the same every month, the breakdown of principal repayment and the amount of interest rate will differ for each month — typically you won’t have the same loan balance each month. Learning how to use and read amortization schedules is vital in settling mortgages — through this the lender would be aware of the future principal and interest payments, as well as the remaining loan balance.

Calculation of Interest on the Amortization Schedule

The interest portion is the product of the remaining balance of the opening principal multiplied by the monthly interest rate. The monthly interest rate on the other hand is the remainder of the yearly interest rate divided by twelve months. The outstanding principal and interest should always reflect in the amortization schedule. If the exceptional principal decreases with each month of successful repayments, the interest rate would also subside.

Example of Amortization Table

Month Payment Interest Principal Balance
1 $853.79 37.50 816.29 $9,183.71
2 $853.79 34.44 819.35 $8,364.37
3 $853.79 31.37 822.42 $7,541.95
4 $853.79 28.28 825.50 $6,716.45
5 $853.79 25.19 828.60 $5,887.85
6 $853.79 22.08 831.71 $5,056.14
7 $853.79 18.96 834.82 $4,221.32
8 $853.79 15.83 837.96 $3,383.36
9 $853.79 12.69 841.10 $2,542.26
10 $853.79 9.53 844.25 $1,698.01
11 $853.79 6.37 847.42 $850.60
12 $853.79 3.19 850.60 $0.00

Types of Amortizing Loan

According to Forbes, loan amortization is the process of scheduling out a fixed-rate loan into equal payments. A portion of each installment covers the amount of interest and the amount of the remaining portion goes toward the loan principal. The easiest way to calculate payments on an amortized loan is to use a loan amortization calculator or table template. The initial payment goes toward paying the interest. Once the payment toward interest is settled, the other half of payment goes toward principal ba

But what is a loan amortization? It is a concept of financing that should be settled in a specific period of time.

Loan amortization also includes installment loans where the lenders settle the same amount each month and the payments go toward interest rates and the outstanding loan principal. Known types of amortizing loans offered in Singapore are:

How Does Unamortized Loan Works

A lender with an unamortized loan will only settle the interest within the agreed loan period. That means the lender should settle the principal balance by making a final huge payment at the end of the loan term.

Monthly payments in unamortized loans are naturally lower — the downside is that balloon payments can be challenging to settle in one go, thus planning and saving ahead of time is very important. Good thing, the lender can make extra monthly payments during the loan period to ease the burden of paying it all at once — the payment goes toward the principal loan.

As hard as it may sound, this method isn’t the best idea one is looking for.

Examples of common unamortized loans are:

  • Interest-only loans
  • Credit card
  • Home equity lines of credit
  • Loans with a balloon payment, such as a mortgage
  • Loans that allow negative amortization where monthly payments are less than the interest accumulated during the loan period

Other Things You Need to Know

What Can You Do if Balloon Payment is Due?

Even before applying for balloon loans, make sure that you have at least saved up just in case things don’t go as planned. Here are three ways you could settle the balloon loan when it is due:

• Refinancing – this might sound like a risky advice but one way to save yourself from the hassle is to get another loan that would pay off the loan balance. The goal is to extend your loan period by adding another 5 to 7 years.

Another way is to refinance a home loan into a 15-30 years mortgage. It may sound easy but in order to pull this off, you have to qualify for the new loan — which means all of your credit, income, and assets are needed to be intact and in good shape.

The risk lies on the fact that if you go for an extended or longer loan period, the interest costs might swell up.

• Sell the asset – another way to settle your loan balance is to sell whatever you bought with the loan.

• Pay it off if you have a decent amount of money in the bank that could cover your loan balance completely, paying it off would be the most hassle free way of repaying your debt. This is the most ideal way of repaying your loans but this does not happen all the time. It’s best to have a fall back plan before applying for any loan.

Revolving Debts

Revolving debt usually comes with variable interest costs.

Revolving debt is the money you owe from an account that lets you borrow against a credit like. Just like any other loans you have to settle the payment on time. But this time, the interest in your monthly payment may have an adjustable rate. Unlike in a mortgage amortization that requires you to start paying the same monthly payment, revolving debts don’t require you a fixed monthly payment.

Unlike installment credit accounts, revolving credit accounts don’t have specific loan terms. You are allowed to borrow money whenever you need it.

Types of revolving credit accounts

  • Debt from credit cards
  • Debt from HELOC (home equity line of credit)

These types of credit accounts are called revolving accounts because the lenders are not obliged to make full monthly payments to settle off the remaining balance. HELOCs work just as the same with credit cards, and ask lenders to have a minimum monthly payment.

Yes, you don’t have to pay off the remaining balance immediately, but being a responsible borrower can do you good. Having advanced payment or paying some of your debts if you can increase the available credit line.

Adjustable Rate Mortgage vs Fixed Rate Mortgage

Adjustable rate mortgages (ARM) are housing loan in which the lender can alter the interest payment — meaning, lenders can change the interest rate. While Fixed rate Mortgage on the other hand, has fixed interest rate throughout the during of the loan.

You have to remember one thing: in Singapore’s fixed rate loans are not structured the way it is understood in other countries. Singapore has no fixed rate throughout the loan.

However, fixed rate loans in Singapore are not structured the way it is understood in many parts of the world because they don’t come with fixed interest rates throughout the life of the loan.

Learn More: Mortgage Loan Processing Checklist

Conclusion

Be it a real estate loan or multiple auto loans, you have to settle mortgage payments on time. Referring to your amortization table can help you plan ahead of time and you can make sure that you are not missing any payment.

Having a better understanding of ‘amortization’, ‘loan amortization’, ‘amortization schedule’, credit cards, mortgage, and how banking solutions compute the applied interest rate can keep you way from future hassle and would help you settle your payment smoothly .

A basic yet the most effective advice you could get to keep you on top of your banking experience, is to pay your debt or mortgage whenever you have an extra amount of money with you.