For a fixed loan, periodic loan payments may stay the same over the life of the loan, but interest payments may change from one period to the next. However, a fixed loan does guarantee a fixed interest rate over the entire loan term, assuming payments on the loan are made at the end of each period. Depending on the amount of principal outstanding at the beginning of each period, interest payment may go down, remain the same or go up when compared with the previous period.
Interest charges on a fixed loan are calculated periodically based on the corresponding interest compounding period. To determine interest expense for each period, multiply the fixed interest rate by the amount of outstanding principal at the beginning of the period. Any loan payments made at the end of the period are first applied to cover the interest expense in the period. Depending on whether the interest expense is fully covered, the amount of principal for the next period can be smaller, unchanged or larger, resulting in a smaller, equal or larger stated interest payment for the next period.
Normal Loan Amortization
Loan amortization refers to the repaying of a loan by installments over a scheduled period of time. A loan can be amortized--the principal owed is brought down to zero at the end of the loan term--only if the periodic loan payments are large enough to pay off both the interest that has accrued during the period and reduce outstanding principal. Because over time each loan payment further reduces outstanding principal, interest expense as calculated goes down period after period.
A normal loan amortization requires a fixed amount of payment each period, which may not be affordable for some borrowers when beginning the repayment process. One alternative offered by lenders is to have borrowers start their loan repayments by paying interest only for certain periods until they are able to make the higher amortization payments. When paying interest only, the outstanding loan principal remains the same from one period to the next, as no extra payments are applied to principal. With a fixed interest rate and unchanged principal, interest payment is left constant for all related periods.
Negative Loan Amortization
Negative amortization is the opposite of normal loan amortization. Instead of paying off interest and reducing outstanding loan principal over time, negative amortization increases the amount of loan owed and causes interest payments to go up over time. Negative loan amortization happens when loan payments for any given period are less than the stated interest expense for the same period. As a result of interest compounding, any unpaid interest is added to the current outstanding principal. With an increased outstanding principal, the calculated interest payment for the next period will go up.
An investment and research professional, Jay Way started writing financial articles for Web content providers in 2007. He has written for goldprice.org, shareguides.co.uk and upskilled.com.au. Way holds a Master of Business Administration in finance from Central Michigan University and a Master of Accountancy from Golden Gate University in San Francisco.