Term Loan vs Amortized Loan: Key Differences and How to Choose

When taking out a real estate loan, two key factors determine how you pay it back – the loan term and amortization period Both affect your repayment schedule, interest costs, cash flow flexibility, and more.

Understanding the difference between a loan’s term versus its amortization allows you to optimize financing for your investment property goals.

This guide will compare term loans and amortized loans, discuss their pros and cons, provide examples, and offer tips on choosing the right loan structure.

Overview of Loan Term and Amortization

First, let’s define these two central loan concepts:

Loan Term – The loan term is the overall length of time you have to repay the loan until maturity Common real estate loan terms are 5, 10, 15, 20, and 30 years.

Amortization – The amortization period determines how the principal loan balance gets paid off over time. With amortized loans, your payments apply more to interest upfront and more to principal later.

For some loans the term and amortization schedule align. For others, they differ. This leads to the categorization of term loans and amortized loans.

Term Loans

A term loan has loan payments spread evenly over the term, with a large balloon payment of the remaining principal due at maturity.

Characteristics:

• Term and amortization period are different

• Payments based on interest-only or moderate principal

• Large balloon payment required at the end

Pros

• Smaller periodic payments free up cash flow

• Interest-only options further reduce payments

• Works well for shorter-term projects

Cons

• Risk of needing to refinance the balloon payment

• Potentially higher payments later if rates rise

Term loans give flexibility today through lower payments, but less predictability long-term. The risk comes due when the balloon payment is owed.

Amortized Loans

With an amortized loan, the term and amortization align so that you fully pay off the principal over the term through your regular repayments.

Characteristics:

• Term length = amortization schedule

• Payments blend principal and interest

• The balance declines to zero by maturity

Pros

• No balloon payment due at the end

• Forced equity build-up through principal paydown

• Lower interest costs overall

Cons

• Higher periodic payments

• Less flexibility if you want to exit early

Amortized loans create payment predictability and avoid a big lump sum, but reduce cash flow flexibility during the loan.

Comparing a 5-Year Term Loan vs a 5-Year Amortized Loan

Let’s look at a hypothetical example to highlight the differences:

You take out a $500,000 commercial real estate loan.

5-Year Term Loan

• 5-year term

• 30-year amortization

• 6% interest

• Payments based on a 30-year schedule

• $477,415 balloon payment due at the end

5-Year Amortized Loan

• 5-year term

• 5-year amortization

• 6% interest

• Payments based on 5-year amortization

• Loan fully paid off by maturity

The term loan has lower periodic payments but requires you refinance or pay the large balloon. The amortized loan builds equity through principal paydown but squeezes cash flow with higher periodic payments.

Which Is Better – Term or Amortized Loan?

So which loan structure wins out? The right choice depends on factors like:

Investment Strategy – Amortized loans create forced equity for buy-and-hold investors. Term loans provide flexibility for fix-and-flip investors.

Cash Flow – If you need to minimize payments, interest-only term loans help. Amortized loans drain more cash flow.

Risk Tolerance – Are you comfortable with refinancing uncertainty down the road? Or do you prefer predictability?

Asset Type – Properties with stable cash flow suit amortized loans. Riskier or transitional assets pair better with term loan flexibility.

Market Conditions – In high interest rate environments, shorter term loans minimize risk. Stable rates favor long-term amortized loans.

Exit Strategy – Will you sell soon, or hold long-term? Amortized loans build equity for selling. Term loans allow quicker exits.

Analyze these factors in your situation to decide if a term, amortized, or blended loan structure fits best.

Tips for Choosing the Right Loan Amortization and Term

When reviewing loan options, keep these tips in mind:

• Compare scenarios of how term loans vs amortized loans affect cash flow, equity build-up, and sales proceeds

• Crunch the numbers at different terms – how does a 10-year amortized loan compare to a 20-year?

• Look at “partially amortized” loans blending features of term and amortized loans

• Consider using separate construction and permanent loans with tailored terms

• Weigh if lower payments today are worth higher costs long-term

• Research potentialballoon loan refinancing options in case you need to go that route

• Ensure you can cover the balloon payment through refinancing, sales proceeds, or cash reserves

Modeling different combinations gives you the flexibility to structure real estate loans optimally for your investment horizons and risk preferences.

Recap & Next Steps

Term and amortization define distinct loan payback schedules. Term loans offer predictable payments but large balloon dues. Amortized loans build equity through gradual principal reduction without any balloon.

Blending features provides further flexibility to match financing to your property goals. Look at both in isolation and together when assessing loan programs.

Now it’s time to put this knowledge into action! Reach out to lenders to start exploring loan term and amortization scenarios for your next real estate project.

The right loan configuration saves money and optimizes your equity. By proactively comparing term loan vs amortized loan options, you can make a well-informed, strategic financing decision.