Unless you have a true no-interest loan, which includes certain types of consumer loans or loans for medical financing, you’ll pay more for the money you borrow than what you actually receive. If you have a mortgage, you understand this concept well. The interest you pay to your lender for the privilege of borrowing money is worked into your loan payments. But it depends on the specific way your loan is structured that determines how you’ll pay back the interest.
In a straight-line amortization schedule, each payment of principal remains the same while the interest payments vary, resulting in varying installment payments. In a mortgage style amortization schedule, each installment payment is the same, but the amounts of principal and interest vary over the life of the loan.
Interest Treatment for Loan Amortizations
A loan is amortized when it has scheduled payments that include principal and interest. Over time, the total amount of the loan – including principal and interest – is reduced until your debt is satisfied. The difference in mortgage style amortization and straight-line amortization hinges on the amounts of principal and interest you pay back with each installment payment.
Mortgage Style Amortization
Most mortgages follow the mortgage style amortization method. Although each installment payment remains the same throughout the life of the loan, the amounts of principal and interest vary with each payment. At the beginning of a mortgage style amortization loan, the interest portion of each payment is higher than the principal portion of each payment. Over time, the principal and interest portions become nearly equal; but toward the end of the loan term, the principal portion of each payment is greater than the interest portion.
In the straight-line amortization method, each principal payment during the life of a loan remains the same. It’s the interest that varies with each installment payment, calculated on the remaining loan balance. Unlike the mortgage style amortization method, which yields equal installment payments, the straight-line amortization method yields installment payments that vary. Near the beginning of the loan term, installment payments typically are higher; but as you get closer to the end of your loan term, your payments decrease.
Straight-Line Vs. Mortgage Style Amortization
Generally, straight-line amortization offers the quickest way to reduce the principal portion of a loan. Its drawbacks, however, include variable payments that are higher in the beginning of the loan term. Mortgage style amortization offers a more methodical and predictable way of paying off your loan, but it’ll take you a while to get to the meat of the principal portion of your mortgage while you’re making higher interest payments in the beginning.
Straight Mortgage Definition
Straight-line amortization is not the same as a straight mortgage loan. A straight-term mortgage, or mortgage straight note, is structured so that you make interest-only installment payments. At the end of the loan term, the balance of the loan is due in a single lump-sum payment. A straight note is also called an interest-only loan or a bullet loan. “Interest-only” doesn’t imply that you pay back only the interest on the note; it simply means that you only make interest payments during the term of the loan until you repay the principal amount at the end of the term.
Unlike most mortgages, which have longer terms of 15 to 30 years, a straight-term loan matures in two to 10 years, with no option for early payoff.
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