If you’ve ever looked into how mortgage loan repayment works, you’ve likely heard the term “amortization.” Amortized loans are the most common types of real estate loans, offering a predictable monthly payment with decreasing interest payments instead of compounding interest over the loan term.
All investors should know how amortization in real estate works and how it can impact your monthly payment, so let’s dive in.
What Is Amortization?
Amortization is a gradual process, allowing a borrower to pay off the loan amount in equal payment installments while paying down the principal and interest balances in varying amounts over the loan term.
Real estate mortgages use amortization to ensure that borrowers have a set mortgage rate every month (assuming a fixed interest rate), though over time their principal payments become larger as the interest payments drop. If you make extra payments, you can decrease the principal amount, which in turn decreases the total amount of interest owed and the lifespan of the loan.
On the first day the loan is funded, the entire balance is outstanding.
There are a few different types of amortization to consider when choosing a mortgage loan. They include the following:
In positive amortization loans, lenders require the borrower to pay part of the principal with each loan payment. This reduces their repayment risk. The loan balance, therefore, will decrease with each monthly payment.
In other words, you’ll likely start the loan with a higher percentage of your payment going to interest instead of the principal, but every month the loan balance ratio shifts until eventually each principal payment is more than the interest payment.
When fully amortized loans use positive amortization, the entire loan balance will be paid off by the completion of the loan.
With negative amortization, borrowers make the required monthly payments on a loan, but it…