Loan Term vs Amortization Period. Difference Explained

Loan Term vs Amortization Period

Updated - 2022.02.09

When it comes to mortgages, these terms are often used interchangeably, but they mean two different things in reality. The loan term and amortization period are two terms you need to understand when looking at the different types of mortgages available to you. This article will break down and explain the loan term vs amortization period so that you can make up your mind which type of mortgage is best for you.

Loan Term vs Amortization Period. All You Need to Know

Loan Term vs Amortization Period

When considering a mortgage, two essential aspects to keep in mind are the amortization period and the mortgage term. The amortization period – what the time limit is for you to pay off your loan, and the mortgage term is how long you’ll keep your loan. Together, these two components have a significant effect on what your overall costs, interest rates, and monthly payments will be.

Amortization Period: What Is It?

A home loan amortization period is the duration it should take for a homeowner to pay off their loan in full. It’s typically calculated as a function of monthly payments and interest rates.

Your monthly payments will be higher with a shorter amortization period. But, you may pay your mortgage off much sooner. It could be a good option for those who want to save money on interest over the long term.

A long amortization period is one way that lenders make high-priced mortgages available to people who can’t afford the larger payments needed to cover a shorter amortization. While it will take you longer to pay off your loan, a more extended payment period can help you qualify for the home of your dreams that would otherwise be out of reach while ensuring lower payments.

Loan Term: What Is It?

A loan term is an actual time it takes to repay the principal amount. The repayment period of a loan varies from one borrower to the next. Outlined below are two critical factors that significantly influence it:

The individual wants of the borrower. A debtor may, for instance, intend to buy a property, improve it, and rent it until it reaches stabilization. In this scenario, the mortgage could be for a shorter time than the one intended to be owed for a longer duration.

The time the bank is willing to commit to a borrower. The main reason lenders won’t commit to long-term loans is simple: they don’t know what will happen in the future. Specifically, they cannot predict what the economy will look like in a year or two, much less in fifteen years. There are too many potential variables and unknowns for them to feel safe committing to a particular loan.

A real estate investment loan period can vary from 5 to 30 years, although most are inside the 5–10-year bracket. It’s a very short-term obligation for lenders, and it gives borrowers adequate time to carry out their estate business strategy.

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How to Calculate a Loan’s Payment?

Two of the four parameters required to compute a loan’s repayment and build an amortization plan are the loan period and amortization. The loan balance plus interest rate are the remaining two. Consider the following scenario: an entrepreneur is looking for a $1,000,000.00 loan. It does have a 5-year period, a 20-year amortization length, and a 6-percent interest rate.

Instead of manually calculating the premium, these factors can be entered into a fiscal calculator or worksheet application to generate a monthly bill of $7,164.

Example How to Calculate a Loan's Payment

Loan Term vs Amortization Period. Difference Explained

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Amortization Schedule. What Is It?

A loan amortization schedule contains essential information regarding your mortgage and how you will repay it. It usually provides a detailed summary of every payment you’ll have to make throughout the loan’s term. The installment amount that goes to the principal and interest gets determined by the repayment schedule. After each monthly payment, you’ll usually receive the outstanding loan balance, so you can see how your overall debt will decrease over the time of the loan’s repayment.

A breakdown of the loan payments is usually included after the amortization plan. You can also find it in a different section. The report will sum up all of your interest payments throughout your loan’s life and check that the aggregate of your principal payments equals the loan’s overall outstanding amount.

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How to Calculate an Amortization Schedule?

It’s pretty simple to create a credit amortization schedule, provided you understand the monthly loan payment. Beginning with the first month, multiply the entire amount owed by the lender’s interest rate. Divide the answer by 12 and find your monthly interest on the loan with monthly installments. Remove the interest rate from the total monthly payment. The difference is applied to the original. Apply the same method for the second month- rather than starting with the loan’s original amount, begin with the outstanding principal amount of the first month. Your original should be $0 by the conclusion of your loan period.

Example How to Create an Amortization Schedule

Loan Term vs Amortization Period. Difference Explained

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Details on Amortization Periods

loan term vs amortization period

The term “amortization period” denotes how long it might take to pay off the mortgage completely. Since mortgage companies levy interest on the loans, the more time it takes for a borrower to pay off a loan, the more the interest one would pay. The amortization term is employed in calculating the monthly payment, together with the specified interest rate.

A portion of every monthly premium will be used to pay interest accrued on the loan since the last installment, and the remaining will be used to lessen the mortgage principle. Little interest will be charged when the mortgage original is lowered, but more is allocated to the original, and the loan balance is eliminated throughout amortization.

A reduced amortization time implies you’ll pay less interest throughout your loan’s life.

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Payments Work on Principal, Interest

A bigger percentage of your’ monthly payback amount’ falls toward interests at the start of the amortized loan. This is frequent with long-term mortgages, in which most of your monthly payment goes toward interest, and only a small fraction goes toward paying off the original. With time, your payments toward the principal get bigger, and you pay less interest.

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The amortization period vs loan term is both terms that relate to the total length of a loan. However, they are not the same thing. Understanding the difference between the two can help you keep your mortgage payments under control and ensure you repay your loan on time.

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