What is an amortized loan?
An amortized loan is a loan with scheduled periodic payments that apply to both principal and interest. An amortized loan payment begins by paying the corresponding interest expense for the period, after which the remainder of the payment reduces the principal. Current amortized loans include car loans, home loans and personal loans of a bank for small projects or debt consolidation.
How a muted loan works
Since interest is calculated based on the last loan closing balance, the interest portion of the loan payment decreases as payments are made. In fact, any payment exceeding the amount of the interest contributes to reducing the capital, which reduces the balance on which the interest is calculated. As the interest portion of a depreciation loan decreases, the main portion of the payment increases. As a result, interest and capital have an inverse relationship in payments over the amortized loan term.
An amortized loan is the result of a series of calculations. First, the current loan balance is multiplied by the attributable interest rate for the current period to determine the interest due for the period. (Annual interest rates can be divided by 12 to find a monthly rate.) By subtracting the interest due for the period from the total monthly payments, you get the amount in euros of principal paid during the period.
The amount of principal paid during the period is applied to the unpaid balance of the loan. As a result, the current balance of the loan minus the amount of principal paid during the period gives the new unpaid balance of the loan. This new balance is used to calculate the interest for the next period.
Amortized loans apply each payment to both interest and principal, initially paying more interest than principal until the ratio is ultimately reversed.
Amortized Loans vs. Balloon Loans, Revolving Debts and Credit Cards
Here’s how you can distinguish these three types of loans. When you take out a loan, make sure you get the type you need.
- Depreciated loans are usually repaid over an extended period of time in equal amounts for each payment period, although there is still the possibility of paying more and thus further reducing the capital.
- Loan on the other hand, generally have a relatively short duration and only a portion of the principal balance of the loan is amortized over that period. At the end of the period, the remaining balance is due as a final repayment, which is significant and generally represents at least double the amount of previous payments.
- Revolving debt and credit cards do not have the same characteristics as an amortized loan because they do not have fixed payment amounts or a fixed loan amount.
Example of amortization loan schedule
Amortized loan calculations can be displayed in a depreciation schedule. The table lists the relevant balances and amounts in euros for each period. In the example below, each period is a row of the table, while the columns are the payment date, the main part of the payment, the interest portion of the payment, the total interest payments to date, and the date of payment. final balance unpaid. The following table extract refers to the first year of a € 165,000 mortgage loan over 30 years, at an annual interest rate of 4.5%.