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Amortization refers to the repayment schedule for mortgage loan principal (the capital amount borrowed).
Lenders generally require you to repay part of the principal with each loan payment to reduce their repayment risk. This is known as positive amortization, and it results in the loan balance decreasing with each payment. The length of a loan’s amortization schedule does not have to equal the maturity of the loan (i.e., it can be longer, but not shorter than, the loan term). For instance, you can have a 30-year loan with a 30-year amortization term, or a 10-year loan with a 30-year amortization term, but not a 30-year loan with a 10-year amortization term.
A loan whose term and amortization schedule are equal is a fully-amortizing loan, in which the loan is fully repaid over the course of the term through the monthly payments. If the loan matures sooner than the amortization period, all remaining principal is due with the final payment, which is known as the balloon payment.
The original way real estate professionals solved for the payment amount was by calculating the annuity factor.
The mortgage constant was then computed. The mortgage constant is calculated simply as the reciprocal of the annuity factor. Once you have the mortgage constant (expressed as a percentage), you can simply multiply the resulting percentage by the total principal amount to get the annual amortizing (constant) loan payment amount. All else equal among loan alternatives, a borrower generally prefers longer to shorter amortization, because they prefer to repay their loan later than earlier.
In addition to traditional loans for property acquisition, lender also offer accrual construction loans. With these loans, principal amounts needed for project costs are borrowed monthly (through a loan draw request), and loan interest accrues (accumulates) and is added to the loan principal balance. This is known as capitalized interest), as opposed to the current-pay interest) of non-accrual loans. Because the loan principal outstanding is growing over time (rather than decreasing as with positive amortization loans), accrual loans are also called negative amortization loans. Since interest that is not paid is added to the principal owed, new interest is charged on old unpaid interest plus the cumulative principal draw amount. In reality, interest is included in each draw of principal.
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The repayment of the principal borrowed from a lender.
The capital amount borrowed from a lender.
The length of time over which loan principal can be outstanding. Also known as the loan term.
The length of time over which loan principal can be outstanding. Also known as the loan maturity.
A loan on which only interest is paid on the outstanding principal until the time of the final monthly payment, at which point the entire principal balance is also repaid.
If the amortization term exceeds the loan term, a final debt service payment that repays all remaining principal.
Repayment of the loan principal with each loan payment, which reduces lender repayment risk; results in the loan balance decreasing with each payment.
The contractual schedule of principal and interest payments owed by the borrower to the lender for the principal borrowed.
The interest rate- and amortization term-based factor whose reciprocal is the mortgage constant. The mortgage constant is the percentage of the original loan principal amount that when multiplied by the loan principal amount, gives you the annual constant payment (comprised of both principal and interest).
The percentage of the original loan principal amount, that when multiplied by that full principle amount, produces the constant annual loan payment amount inclusive of interest and principal. The mortgage constant is solved for by taking the reciprocal of the interest rate- and amortization term-based annuity factor.
A loan for which the term and amortization schedule are equal; the loan is fully repaid over the course of the term through the monthly payments.
A loan amortization schedule that is not constant throughout the entire loan term (e.g., an amortizing loan with a front-end interest-only period).
A loan in which the annual amortization dollar amount remains constant but the total payment amount changes.
A short-term loan provided by a lender for the purpose of new property construction. The principal amounts needed for incurred project costs are borrowed monthly (through a loan draw request) and loan interest accrues (accumulates) and is added to the loan principal balance. As such, a construction loan is a form of a negative amortization loan.
A periodic request from a construction loan borrower that the lender advance funds, based on project costs incurred for which the borrower has been invoiced or for which they have already paid.
Construction loan interest amounts that are charged but allowed to accrue (accumulate) and be added to the loan principal balance, instead of being paid current each month. Also known as capitalized interest.
Construction loan interest amounts that are charged but allowed to accrue (accumulate) and be added to the loan principal balance, instead of being paid current each month. Also known as accrued interest.
Interest payments made monthly.
The portion of the overall negative amortization loan amount that is reserved for the eventual total interest amount.
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