When considering taking out a loan of any kind, itâs important to understand the repayment model. Otherwise, youâll be flying blind into an expensive financial commitment. One common repayment structure is a fully amortized loan.
Fully amortized loans are commonplace when it comes to financing major purchases like a home or car. But what exactly does “fully amortized” mean and what makes these loans different than other types of financing? This comprehensive guide will explain everything you need to know about fully amortized loans.
What is a Fully Amortized Loan?
A fully amortized loan is one where the loan payments are structured so that the entire loan balance will be paid off by the end of the loan term if all payments are made on time
With a fully amortized loan, each payment is made up of both principal (the amount borrowed) and interest. In the early stages of the loan, the payments are mostly interest and include only a small amount of principal. But as the loan progresses, the principal portion gets larger while the interest portion gets smaller.
By the end of the full term, the remaining balance will be completely paid off as long as the payments have been made according to schedule This differs from loans that have balloon payments or interest-only periods
How Do Fully Amortized Loans Work?
On a fully amortized fixed-rate loan like a 30-year mortgage, the monthly payments stay the same over the life of the loan The only thing that changes is how much of each payment goes toward interest vs principal.
For example, let’s look at a 30-year fixed-rate mortgage with a 4% interest rate and $200,000 balance:
- Month 1 payment = $954
- Interest = $666
- Principal = $288
- Month 120 payment = $954
- Interest = $488
- Principal = $466
As you can see, the payment stayed the same each month but more went to paying down the principal as time went on.
The amortization structure is a bit different for adjustable-rate mortgages (ARMs) where the interest rate can fluctuate after an initial fixed-rate period. With an ARM, the payment gets recalculated anytime the rate changes so that the loan remains on track to be fully paid off by the end of the term.
Pros of Fully Amortized Loans
There are several benefits that come with choosing a fully amortized loan:
-
Predictable payments – Since the monthly payment stays the same, it’s easy to budget for.
-
Payoff security – You can have confidence that as long as you make the payments, the loan will be entirely paid off by the end of the term.
-
Interest savings – More of each payment goes toward the principal as time goes on, reducing the total interest paid over the life of the loan.
-
No balloon risk – There is no balloon payment shock when the loan matures.
Cons of Fully Amortized Loans
However, there are also a few potential downsides:
-
Paying mostly interest early on – You build equity slower in the early years since most of the payment goes toward interest.
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Prepayment penalties – Some lenders charge fees for paying off a loan early.
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Less flexibility – The fixed payment schedule doesn’t allow wiggle room if finances get tight.
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Refinancing risk – If rates fall, refinancing into a lower rate loan often makes sense but comes with fees.
Fully Amortized vs Interest-Only Payments
Some loans, like adjustable-rate mortgages, offer interest-only payments for a set period of time. With interest-only, the payment only covers the monthly interest charges and does not pay down any principal during that period.
This makes the payment lower at first compared to a fully amortized loan. However, once the interest-only period ends, the payment will jump up significantly when the principal and interest payment kicked in. This makes budgeting more complicated.
Paying only interest while putting no dent in the loan balance also means you build equity slower in the home. And it can leave borrowers unprepared when the principal and interest payments begin unless they’ve diligently planned ahead.
Examples of Fully Amortized Loans
Some of the most common fully amortizing loans include:
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Mortgages – The standard fixed-rate mortgage fully amortizes with equal monthly payments over 15 or 30 years.
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Auto loans – Car loans from a bank or dealer are generally fully amortizing over 3 to 6 years.
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Personal loans – Unsecured personal loans offered by banks and online lenders typically have fixed monthly payments and amortize over 2 to 7 years.
-
Student loans – Many government and private student loans amortize over 10 to 25 years.
These type of installment loans have predictable fully amortizing payment schedules that appeal to both lenders and borrowers.
Tips for Managing a Fully Amortized Loan
Here are some tips to make the most of a fully amortized personal loan:
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Shop around for the lowest interest rate possible, since you’ll be paying this over the life of the loan. Even small rate differences can really add up.
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If your budget allows, make extra principal payments to pay the loan off faster and reduce total interest costs.
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Be cautious about extending the loan term just to lower payments, as you’ll end up paying more interest in the long run.
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Review the loan agreement carefully and understand any fees for early payoff or refinancing. Factor these into any decision to refi later.
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Use online calculators to forecast how different payment amounts, terms, and interest rates impact your total interest costs and equity over time.
The Bottom Line
Fully amortized loans provide structured payment plans that appeal to both lenders and borrowers looking for predictable schedules. When shopping for a fully amortizing loan, be sure to compare interest rates and run the numbers to find the best overall value for your situation.
Fully Amortized Loan FAQs
A fully amortized loan can sometimes be referred to as a fixed-payment loan, but there are slight differences.
Both loan types have consistent, fixed payments that go towards the loanâs principal balance and interest. But the main difference is that a fixed-payment loan could still have a balance at the end of the loan term. Whereas a fully amortized loan, the amount is completely paid off by the end of the loan term.
Amortization Payment Schedule Example
So, you know what a fully amortizing loan means. But how does a fully amortized mortgage play out in real life?
The table below illustrates an amortization schedule for a 30-year fixed-rate mortgage. The total loan amount is $400,000 at a fixed interest rate of 4.5%.
|
Month |
Fixed Monthly Payment Amount |
Principal |
Interest |
Balance |
|---|---|---|---|---|
|
1 |
$2,026.74 |
$526.74 |
$1,500 |
$399,473.26 |
|
2 |
$2,026.74 |
$528.72 |
$1,498.02 |
$398,944.54 |
|
3 |
$2,026.74 |
$530.70 |
$1,496.04 |
$398,413.84 |
|
4 |
$2,026.74 |
$532.69 |
$1,494.05 |
$397,881.15 |
|
⦠|
⦠|
⦠|
⦠|
⦠|
|
357 |
$2,026.74 |
$1,996.62 |
$30.12 |
$6,034.91 |
|
358 |
$2,026.74 |
$2,004.11 |
$22.63 |
$4,030.80 |
|
359 |
$2,026.74 |
$2,011.63 |
$15.12 |
$2,019.17 |
|
360 |
$2,026.74 |
$2,019.17 |
$7.57 |
$0 |
Now, letâs see how the amortization schedule of a 30-year fixed-rate mortgage stacks up against a 5/1 ARM.
In this case, the initial mortgage balance is $400,000 with a term of 30 years. After 60 months, your 4.5% mortgage interest rate is expected to increase by 0.25% every 12 months with an interest cap of 12%.
|
Month |
Monthly Payment Amount |
Principal |
Interest |
Balance |
|---|---|---|---|---|
|
1 |
$2,026.74 |
$526.74 |
$1,500 |
$399,473.26 |
|
2 |
$2,026.74 |
$528.72 |
$1,498.02 |
$398,944.54 |
|
3 |
$2,026.74 |
$530.70 |
$1,496.04 |
$398,413.84 |
|
4 |
$2,026.74 |
$532.69 |
$1,494.05 |
$397,881.15 |
|
⦠|
⦠|
⦠|
⦠|
⦠|
|
357 |
$2,842.74 |
$2,743.12 |
$199.62 |
$8,377.72 |
|
358 |
$2,842.74 |
$2,767.69 |
$75.05 |
$5,610.03 |
|
359 |
$2,842.74 |
$2,792.48 |
$50.26 |
$2,817.55 |
|
360 |
$2,842.74 |
$2,817.55 |
$25.24 |
$0 |
Whether your home loan is an ARM or fixed-rate mortgage, a fully amortized loan ensures your entire principal balance gets paid off by the end of the loan term. Along the way, the percentage of your payment allocated toward the principal balance will increase while the percentage allocated toward the interest charges will decrease.
Loan Amortization Explained
FAQ
What is the difference between a partially amortized loan and a fully amortized loan?
What is the meaning of amortized loan?
What is the difference between interest-only and fully amortized?
What is a fully amortized loan?
Fully amortized loans are usually home loans, auto loans or personal loans. They can be secured (backed by the borrower’s assets) or unsecured. Fully amortized loans have schedules such that the amount of your payment that goes toward principal and interest changes over time so that your balance is fully paid off by the end of the loan term.
Is a mortgage fully amortized?
Almost all mortgages are fully amortized — meaning the loan balance reaches $0 at the end of the loan term. The same is true for most student loans, auto loans, and personal loans, too. Unlike with credit cards, if you stay on schedule with a fully amortized loan, you’ll pay off the loan in a set number of payments.
What happens if a loan is fully amortized?
If the borrower makes payments according to the loan’s amortization schedule, the debt is fully paid off by the end of its set term. If the loan is a fixed-rate loan, each fully amortizing payment is an equal dollar amount. If the loan is an adjustable-rate loan, the fully amortizing payment changes as the interest rate on the loan changes.
What is a fully amortizing payment?
A fully amortizing payment is a periodic loan payment made according to a schedule that ensures it will be paid off by the end of the loan’s set term. Loans for which fully amortizing payments are made are known as self-amortizing loans. Traditional fixed-rate, long-term mortgages typically take fully amortizing payments.