What is an amortized loan?

An amortized loan is a loan where payments are the same amount each month. Each payment pays part of the interest on the loan and part of the principal, or amount borrowed. An amortized loan can be fully amortized, which means that payments will remain the same until the indicated period the loan is repaid. Partially amortized loans alternately mean that at the end of the stated payment period, an additional large payment, called a balloon payment, is due.

In general, an auto loan is likely to be an amortized loan. Especially during the first few months of the loan, most of the payment will likely go towards interest. Very little of the prepayments will actually pay the principal, due to the fact that the amortized loan charges all interest upfront. Thus, with any amortized loan, the gradual payment of principal increases and the payment of interest decreases, although the payment amount remains the same.

The downside of a loan repaying in its early years is that the percentage of property you actually own can be very small. On an amortized car loan, there is usually a point where the resale value of the car is much less than the actual amount you would owe for the car if paid off immediately.

This reverse effect occurs because very little was spent on real principal amounts and a lot on interest. There is usually a payment amount that is less than the total amount owed on the loan. This may not match the actual value of the car.

If you look at a home loan, you'll see the same effect if home values ​​dropped. For example, on a 15-year repayment loan of $100,000 at 7% interest, the payment is close to $900 per month. The principal paid during the first year varies between 300 and 400 USD per monthly payment. A larger payment amount, around USD 500-600, pays the interest on the amortized loan.

At the end of the first year of this amortized loan, you may have US$3,600-4,200 of paid-in capital. If the home's value drops by $10,000 that year and it becomes necessary to resell the home, it will be done at a loss, affecting the value of any down payments you may receive. Even two or three years after payments are made, declining home values ​​can mean that selling the house could result in a total loss of the down payment.

Generally, more ownership of a property can be obtained by paying additional amounts to the amortized loan principal. Typically, you need to find out first whether the credit bureau will allow additional payments to the principal. In addition, it must be ensured that principal payments are clearly marked and credited as such by the bank or lending company. Sometimes making an extra payment on an amortized loan is considered an early start on the next scheduled payment. Be sure to verify that the bank actually credits these payments "to the principal".