What Are Amortized Loans? And How Can They Help You?

Do you need a loan or credit? The extension of money on credit is a vital part of life for most Americans, but the choices and rules can be confusing to new borrowers trying to make the best choices.

Consider the idea of an amortized loan. What does this mean? How does it compare other types of credit or debt? And how can you use what you know about amortized loans to your advantage? Discover a few answers.

Amortization is a financial term that refers to the rate and method in which the principal of a loan is paid off during the life of the loan. Generally, when a loan is fully amortized, each month's payment pays a portion of the principal and a portion of the interest. The rates at which these are distributed is determined by a calculation (amortization schedule) specified within the terms of the loan. 

The actual math that dictates how much of each payment applies to principal and how much to interest can be complicated. You would likely do well to use an amortization calculator or table. One may be provided by your lender. 

At its most basic, an amortized loan's balance each month is multiplied by the interest rate for that period (for example, 10% annual interest divided by 12 months), and this portion goes to the interest. The rest goes to the principal. The reduced principal balance is then used to repeat this calculation next month. The interest portion starts out higher but will be replaced by a growing percentage that goes to the principal. 

Amortized loans have many advantages over other forms of credit. First, they are usually a fixed payment. The amount of interest and principal applied may vary, but the overall payment remains the same — unlike credit cards or other revolving credit. And the interest rate generally doesn't change during the life of the loan.

Second, amortization comes with a set end date. The calculations involved simply don't allow for unlimited payments. So you can't charge up this form of credit and fall into an endless cycle of debt. 

Third, full amortization means that each month, a portion of your loan principal is paid. Some other loans — particularly interest-only or balloon-payment loans — don't apply any portion of your payment to the interest, leaving the initial amount untouched and fully due at the loan's end date.

Amortized loans provide you with some important opportunities to make a strategy that will work for your financial health. 

First, since you can see on an amortization table how much of each payment goes to interest, you know where your money is going. You can also see how the balance will decline and be paid off on a certain date. Armed with this knowledge, you know exactly how much interest you will pay and what the loan will cost so you can easily shop around.

You can also make additional payments toward the principal. Any time you pay an extra portion of principal, the calculated interest reduces not just for one month but for all remaining payments, which adds up fast. A borrower may choose, for instance, to make extra principal payments early on (reducing overall interest) and then stop doing so when the majority of their regular payments go to the balance.

Now that you understand better how amortization works, do you want to learn more about these loans? Start by meeting with the amortized loan experts at Ardmore Finance. Our team can help you find the right credit choice for whatever your situation. Make an appointment today.