How Does an Amortization Schedule Work?

Amortization is the process of paying off a debt into a series of fixed payments. The payment is made up of parts that change over a period of time. The last payment will pay off the final amount remaining on your debt. An amortization schedule provides details about your loan including the amount of each payment that goes toward interest as well as principal.

What Is an Amortization Schedule?

An amortization schedule is a tool used by borrowers so they can see the progress of their payment with each step of amortizing a loan. The principal of an amortizing loan is paid over the life of the loan which has an equal amount of payment every period.

In the beginning of the loan, you will pay more interest. The interest starts to decrease as you pay down your principal which results in more of your payment will be applied to your principal.

Periodic payments are made for amortizing loans which include interest charge and principal repayment. The interest percentage or principal repayment varies for different loans.

Amortization Schedule Methods

There are different methods to amortize a loan which lead to different amortization schedules.

Straight line

Straight line amortization is commonly used in accounting because of how simple it is. It is where the total interest amount is distributed equally over the life of a loan. With fixed periodic total payment and interest amount, the principal repayment is constant over the life of the loan.

Declining balance

This method is an accelerated method of amortization where the periodic interest payment declines, but the principal repayment increases with the age of the loan. The declining loan balance leads to low interest charges which in turn accelerates the repayment of the principal.

Annuity

A loan amortized in the annuity method has a series of payments made between equal time intervals and they are made in equal amounts.

Bullet

The periodic payments of a bullet loan cover the interest charges only. The balance outstanding of a bullet loan remains unchanged over the life of the loan is lowered immediately to zero at maturity.

Balloon

A balloon loan is similar to a bullet loan which the entire principal maturity is repaid. It is amortized with small amounts of principal repayments but leaves the majority paid at majority.

Negative amortization

This is where the total payment of a period is lower than the interest charged for that period. The remaining interest charge will accumulate to increase the outstanding balance of the loan.

What Does a Monthly Amortization Schedule Look Like?

• Payment Number (Payment Month): The payment number column indicates the installment you are on.
• Beginning Balance: this refers to the total amount of principal and interest you owe at the time that payment number is due.
• Scheduled Payment: this column refers to the portion of your amortization schedule with fixed monthly payments.
• Principal: this shows how much of the payment goes toward the actual amount borrowed.
• Interest: the interest column records how much of the payment goes toward the interest this being charged on the loan.
• Ending balance: the ending balance column has the total amount of interest and principal that remains left for you to pay as it corresponds to each payment installment.
• Total (cumulative payment): this shows the total interest you have paid at the completion of each installment payment.

Type of Amortizing Loans

There are lots of types of loans available which work in different ways.

• Auto loans: these are 5-year amortized loans that are paid down with a fixed monthly payment.
• Home loans: these are 15 to 30-year fixed rate mortgages.
• Personal loans: these loans are amortized as well and have 3-year terms with fixed monthly payments and interest rates. You can get them from a bank, credit union or online vendor.

There are loans that also do not get amortized such as:

• Credit cards: this is also known as revolving debt where you borrow repeatedly on the same card and you choose how much to repay each month.
• Interest-only loans: during the interest period, you will pay down the principal if you make additional payments that are above and beyond the interest cost.
• Balloon loans: this requires you to make a large principal payment at the end of the loan’s life.

The Bottom Line

An amortization schedule breaks down the loan payments you have each month and shows what you will be putting toward principal and interest in each payment. As mentioned above, certain loans can be amortized and others cannot.