Fully Amortized Loan: What It Is And How It Impacts Your Payments

When considering taking out a loan of any kind, it’s important to understand the repayment model. Otherwise, you’ll be flying blind into an expensive financial commitment. One common repayment structure is a fully amortized loan. Let’s take a closer look at what this repayment model means for your finances.

What Is A Fully Amortized Loan?

A fully amortized loan is a type of loan where borrowers pay off their balance based on the loan’s amortization schedule. Borrowers who stick to this schedule will pay off their loan at the end of the loan’s term.

Within a fully amortized loan, amortization refers to the amount of principal and interest paid each month during the loan’s term. At the beginning of a loan, the bulk of your payment will cover interest costs. But as you continue further into the loan, the scales will tip. As you near the end of the loan term, your payment will increasingly cover the remaining principal balance.

As a borrower, you can explore what each of your payments will cover through an amortization schedule. It’s useful to see how your loan payments are allocated towards your outstanding principal balance.

How Fully Amortizing Loans Impact Your Payments

Fully amortizing loans have different impacts on different mortgage types.

With fixed-rate mortgages, your mortgage payment will remain the same for the duration of the loan term. The only reasons for the payment to change are if your homeowner’s insurance or property tax bill changes. But the combined principal and interest payment will remain the same.

Although the combined amount of principal and interest will remain the same, the portion allocated towards each expense will change every month. The amount going towards your principal balance will increase every month and the amount paying off your interest will decrease every month. 

With adjustable-rate mortgages (ARMs), the amount of principal and interest in a payment can change after the end of the initial interest rate period. The loan will be re-amortized each time the interest us adjusted. This re-amortization ensures that the loan balance at the end of the term is zero, even if the interest rate increases along the way.

Amortization Payment Schedule Example

So, you know what a fully amortizing loan means. But how does a fully amortized mortgage play out in real life?

The table below illustrates an amortization schedule for a 30-year fixed-rate mortgage. The total loan amount is $400,000 with a fixed interest rate of 4.5%.

Now, let’s see how the amortization schedule of a 30-year fixed-rate mortgage stacks up against an 5/1ARM. In this case, the initial mortgage balance is $400,000 with a term of 30 years. After 60 months, your mortgage interest rate of 4.5% is expected to increase by 0.25% every 12 months with an interest cap of 12%.

With either an ARM or fixed-rate, a fully amortized loan will ensure that you pay off the entire principal balance by the end of the term. Along the way, the percentage of your payment allocated towards the principal balance will increase and the percentage allocated towards the interest charges will decrease.

Fully Amortized Loans Vs. Other Loan Types

Fully amortized loans aren’t the only type of loan product out there. Here’s a closer look at the other types of home loans available.

Interest-Only Mortgages

Interest-only mortgages are a stark contrast to fully amortized loans. With an interest-only mortgage, you’ll only have to make interest payments for a set period of time.

Not all interest-only mortgages work in the same way. Some have interest-only payments that transition into a fully amortizing payment after a set period of time. Others require a balloon payment for the entire principal amount after the interest-only payment term expires.

Neither of the interest-only mortgage structures requires you to work on paying down your principal while making interest payments. In contrast, a fully amortized loan means that at least a portion of each payment works to lower your principal balance.

Partially Amortized Loans

A partially amortized loan strikes a balance between the fully amortized and interest-only mortgage options.

As you make mortgage payments, the funds will cover some of the principal balance and the rest will cover the interest charges. But the principal balance will not be completely paid off by the end of the loan term. With that, there is often a balloon payment looming at the end of your loan term.

Advantages And Disadvantages Of Fully Amortized Mortgages

Every financial product comes with advantages and disadvantages. Here’s what to be aware of.

Advantages

Amortization schedules on a fixed-rate loan simplify your mortgage payment breakdown. With a fixed-rate, fully amortized loan, you’ll always know exactly what your mortgage payment is. Plus, you’ll know exactly how much is going towards your principal balance.

Disadvantages

When you look at the amortization schedule, you’ll quickly spot the main disadvantage. Fully amortized loans force you to pay the bulk of your interest charges upfront. It can take years for the bulk of your payment to go towards your principal balance.

All of the interest payments can be frustrating for those trying to get out of debt.

The Bottom Line

A fully amortized loan is a common option for home buyers. You’ll have peace of mind knowing that your principal balance will be eliminated by the end of the loan term. Want to see how a fully amortized loan would look for you? Take a look at our mortgage amortization calculator.