how an amortized loan works
the interest on an amortized loan is calculated based on the most recent ending balance of the loan the interest amount owed decreases as payments are made this is because any payment in excess of the interest amount reduces the principal which in turn reduces the balance on which the interest is calculated as the interest portion of an amortized loan decreases the principal portion of the payment increases therefore interest and principal have an inverse relationship within the payments over the life of the amortized loan 1an amortized loan is the result of a series of calculations first the current balance of the loan is multiplied by the interest rate attributable to the current period to find the interest due for the period annual interest rates may be divided by 12 to find a monthly rate subtracting the interest due for the period from the total monthly payment results in the dollar amount of principal paid in the period the amount of principal paid in the period is applied to the outstanding balance of the loan therefore the current balance of the loan minus the amount of principal paid in the period results in the new outstanding balance of the loan this new outstanding balance is used to calculate the interest for the next period amortized loans vs balloon loans vs revolving debt credit cards while amortized loans balloon loans and revolving debt specifically credit cards are similar they have important distinctions that consumers should be aware of before signing up for one of them amortized loans are generally paid off over an extended period of time with equal amounts paid for each payment period however there is always the option to pay more and thus further reduce the principal owed balloon loans typically have a relatively short term and only a portion of the loan s principal balance is amortized over that term at the end of the term the remaining balance is due as a final repayment which is generally large at least double the amount of previous payments 2credit cards are the most well known type of revolving debt with revolving debt you borrow against an established credit limit as long as you haven t reached your credit limit you can keep borrowing credit cards are different than amortized loans because they don t have set payment amounts or a fixed loan amount amortized loans apply each payment to both interest and principal initially paying more interest than principal until eventually that ratio is reversed example of an amortization loan tablethe calculations of an amortized loan may be displayed in an amortization table the table lists relevant balances and dollar amounts for each period in the example below each period is a row in the table the columns include the payment date principal portion of the payment interest portion of the payment total interest paid to date and ending outstanding balance the following table excerpt is for the first year of a 30 year mortgage in the amount of 165 000 with an annual interest rate of 4 5 can i pay off an amortized loan early yes to pay off an amortized loan early you can make payments more frequently or make principal only payments since the interest is charged on the principal making extra payments on the principal lowers the amount that can accrue interest check your loan agreement to see if you will be charged early payoff penalty fees before attempting this 