Nearly every commercial real estate transaction involves a loan, and commercial real estate mortgages can be far more complicated than their residential counterparts. In many cases, CRE mortgages offer additional options and nuances that are needed to meet the unique needs of a commercial real estate borrower.
Several of these unique options have to do with the loan’s term and amortization period. These features are often confused for each other, so it is the intent of this article to clear up the differences between a loan term vs. amortization, since they are important inputs into the loan payment calculation.
When taking out a mortgage you’ll come across two terms – amortization term and loan term. While they sound similar they refer to distinct aspects of your mortgage. Understanding the difference is crucial when shopping for a home loan. In this guide, we’ll explain what each term means and how they impact your repayment schedule.
Amortization Term – The Total Repayment Timeframe
The amortization term refers to the entire length of time it will take to repay your mortgage principal and interest in full This is based on the size of your loan, the interest rate, and your regular principal and interest payments.
For example if you take out a $200,000 loan at 4% interest with a 30-year amortization term, it will take 360 monthly payments of around $955 to repay the total mortgage amount of principal ($200000) plus interest over 30 years.
Amortization terms typically range from 15 to 30 years for conventional mortgages. A longer amortization spreads repayment over more time, meaning lower monthly payments. But you pay more interest overall versus a shorter term.
Loan Term – Initial Lock-In Period
Whereas amortization term covers the full payoff period, the loan term refers specifically to the initial number of years that your mortgage terms are locked in.
Common loan terms are 10, 15, 20, and 30 years. Your interest rate, monthly payment, and other loan details remain fixed during this initial term.
For example, you may opt for a 30-year amortization with a 15-year loan term. After 15 years, the loan term ends but you still have 15 years left on the amortization schedule. At this point, you can refinance for better terms.
How They Impact Your Mortgage
The amortization term and loan term intersect to determine your repayment structure. Let’s compare two loans to see the effect:
Loan 1
- Loan Amount: $200,000
- Interest Rate: 4%
- Amortization Term: 30 years
- Loan Term: 15 years
Your principal and interest payment will be set based on the full 30-year amortization schedule, meaning lower monthly payments of around $955. However, your 15-year loan term locks this payment in for only the first 15 years.
Loan 2
- Loan Amount: $200,000
- Interest Rate: 4%
- Amortization Term: 15 years
- Loan Term: 15 years
In this case, your principal and interest payment will be calculated based on the shorter 15-year schedule. This results in higher monthly payments of about $1,432 to repay the loan faster over 15 years.
Impact on Monthly Payments
As you can see, the amortization term has the biggest influence on your monthly mortgage payments. The longer the amortization schedule, the lower your payments will be since repayment is spread over more time.
Meanwhile, the loan term does not directly affect monthly payments. But opting for a shorter loan term limits how long you are stuck paying a higher rate if rates drop in the future.
Renewing When the Loan Term Ends
Once your initial loan term ends, you have choices:
- Refinance your remaining mortgage balance to get a new loan term with better rates
- Switch to payments based on the remaining amortization schedule
- Pay off the mortgage balance in a lump sum
Many borrowers refinance at the end of their loan term if rates are lower. This restarts the clock with a new term and payment.
Key Takeaways
When weighing your mortgage options, look closely at both the amortization term and loan term:
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Amortization establishes your total repayment timeframe – A longer term like 30 years reduces your monthly payments but increases total interest paid.
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Loan term sets your initial fixed-rate period – Shorter terms have higher payments but let you refinance sooner if rates fall.
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Amortization primarily dictates payment amount – Loan term does not directly influence monthly payments.
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Refinancing often makes sense after the loan term – You can get a new rate and term once your initial mortgage contract ends.
Understanding these key differences allows you to find the ideal loan structure. A mortgage advisor can help analyze scenarios to determine the best amortization and loan terms for your financial situation.
Calculating a Loan’s Payment and Amortization Schedule
Loan term and amortization are two of the four inputs that are needed to calculate a loan’s payment and create an amortization schedule. The other two inputs are the loan amount and the interest rate.
To illustrate how the loan term, amortization, amount, and interest rate work together, suppose an investor is seeking a loan for $1,000,000. It has a 5 year term, an amortization period of 20 years, and an interest rate of 6%.
Rather than calculate the payment manually, these variables can be plugged into a financial calculator or spreadsheet program to calculate a payment amount of $7,164 per month. Translating this payment into an amortization schedule is a little bit more difficult.
In the first month, the interest portion of the payment is calculated by multiplying the starting loan amount of $1,000,000 by the interest rate of 6%. The result of $60,000 indicates the amount of annual interest so it must be divided by 12 to get a monthly interest payment of $5,000. This means that in the first payment, $5,000 goes towards interest and the remaining $2,164 goes towards principal. After the first payment, the remaining loan principal is $997,836. This amortizing calculation continues for the entirety of the loan term, at which point the remaining balance is due as a balloon payment. The first 5 and last 5 payments are shown in the amortization table below.
From the table it can be seen that the amount of interest paid goes down a little bit each month and the amount of principal goes up. But, at the end of the loan term, month 60, the outstanding balance of $848,996 becomes due. This is the balloon payment and highlights the risk of a loan with a split amortization (versus a fully amortized loan). There are very few borrowers with this amount of cash to pay off the loan balance in full. As such, the best option is to refinance into a new loan, but there is no guarantee that this loan request will be approved.
What is Loan Amortization?
A loan’s amortization period is the amount of time over which a loan’s payments are calculated. In a commercial real estate transaction, it is common for a loan to have a “split amortization,” meaning that the loan’s term and amortization periods are different.
For example, a loan could have a term of five years, but the payments could be based on a 25-year amortization schedule. For the borrower, this has the benefit of a lower monthly payment to minimize cash outlay, but it also means that there is a “balloon payment” at the end of the term. A balloon payment is one that is much larger than the standard monthly payment and it typically consists of the remaining loan balance at the end of the loan term.
A loan’s amortization period can also vary from one transaction to the next, and it is chosen to accommodate the specific needs of the transaction. However, commercial real estate loan amortization periods typically fall within the range of 20-30 years. Once it is determined, an “amortization schedule” can be created that details exactly how much of each loan payment goes towards retiring the loan’s principal balance versus how much goes towards interest.
Term vs Amortization
FAQ
What is the difference between term loan and amortization?
What does 10 year term 30 year amortization mean?
What is the difference between loan repayment and amortization?
What is the difference between a regular loan and an amortized loan?
What is the difference between amortization period vs loan term?
The amortization period vs loan term is both terms that relate to the total length of a loan. However, they are not the same thing. Understanding the difference between the two can help you keep your mortgage payments under control and ensure you repay your loan on time. Find out about Loan Term vs Amortization Period.
What is the difference between amortization and term?
Amortization is the length of time it takes a borrower to repay a loan in full. The term is the period of time in which it’s possible to repay the loan by making regular payments. So an amortization term is the amount of time it’ll take you to pay off the debt and own something free and clear.
What is an Amortized mortgage?
With an amortized loan, your mortgage is guaranteed to be paid off by the end of the term as long as you make all your payments over the life of the loan. Here’s an example of how an amortization schedule would look for the following loan:
What is a mortgage amortization period?
The term “amortization period” denotes how long it might take to pay off the mortgage completely. Since mortgage companies levy interest on the loans, the more time it takes for a borrower to pay off a loan, the more the interest one would pay.
How do you pronounce amortization?
“Amortization” is pronounced am-ur-ti-ZAY-shun. “Amortize” is pronounced AM-ur-tize. When loan officers talk about amortization, they often mean the loan’s term, or the number of years it will take to pay it in full. A “30-year amortization” and a “30-year mortgage term” mean the same thing.
How do you choose a mortgage amortization term?
You choose an amortization period when you are approved for a mortgage, and decide what term mortgage you want: 30-year, 15-year, etc. That said, the interest rate is usually lower—by as much as a full percentage point—on shorter-term loans that amortize more quickly. What Is the Amortization Term?