Amortization Schedule: Definition, Benefits and Tips

Updated February 3, 2023

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If you're hoping to receive a fixed-rate loan with good terms, an amortization schedule can help with your financial planning. These schedules provide specific details about your payment plan and due dates, which can help you make more informed financial decisions.

In this article, we discuss the various types of amortization schedules and the benefits of using them, and we provide tips to help you understand how to create your own schedule.

What is an amortization schedule?

An amortization schedule is a detailed list of all payments and their due dates for the full duration of a loan. It includes the total loan amount, a fixed interest rate and the loan term. The schedule breaks down the principal debt, which is the original amount you borrowed, the interest, which is the amount a lender or institution charges for lending, and the remaining balance for each payment.

Although loan payments often are a fixed amount, an amortization schedule allocates a greater portion of earlier payments to paying off interest and a greater portion of later payments to the principal debt. There's an inverse relationship between the percentage of principal and interest you pay over the full period of the loan because the interest rate calculation depends on the outstanding loan balance.

Types of amortized loans

The most common types of amortized loans lenders or financial institutions offer include are:

Car loans: The motor vehicle you purchase serves as collateral for a car loan, which you may be able to deduct from your taxes and can help establish a credit record. The term for a car loan usually is three to five years.

Home equity and mortgage loans: A home equity loan helps you construct or purchase a home, and mortgage loans help you purchase a piece of property. The lender or financial institution holds the rights to your home or property for the full loan period, which usually is 15 or 30 years.

Personal loans: Personal loans are useful for a variety of expensive purchases, minor home renovations or even debt consolidation. These are unsecured loans that depend on your credit, and their terms typically are one to five years.

Student loans: Student loans cater to specific educational needs, such as tuition, transportation, accommodation, textbooks, stationery and computers. The benefit of a student loan over a personal loan is higher borrowing limits, and the term for student loans often is 10 to 25 years.

Benefits of an amortization schedule

Here are four practical benefits of using an amortization schedule:

Evaluate loan options easily

Amortization schedules help you evaluate loan options because they highlight the cumulative cost of interest. The same interest rate that permits a small monthly repayment over a 20-year period often costs substantially more in interest compared to a 10-year loan period with a large monthly repayment. Lowering total interest costs leaves you with more money to cover the principal cost of the loan.

Find fixed loan payments

A fixed-rate loan may good a good idea during times of rising interest rates because the monthly loan repayments remain the same. Fixed interest rates remain the same for the loan term, while variable interest rates change with economic conditions. Deciding whether to choose a fixed-rate loan often depends on the interest rate environment and the length of the loan.

Can adjust timelines

The cumulative amount of interest on an amortization schedule can encourage you to adjust the timeline of the loan. Making additional payments reduces the principal amount, which reduces the cost of interest in the following months. Even the smallest additional payment in the first year of the loan can adjust the timeline and help you settle your loan sooner. If you make an additional payment, try to notify the lender to apply it toward the principal and not the interest.

Build equity

When the principal loan amount decreases on the amortization schedule, the amount of equity available to homeowners increases. You can build equity through a marginal increase in your monthly repayments or with extra lump sum payments that reduce the principal amount. This equity is available through a cash-out refinancing plan or a home equity loan. A cash-out refinance replaces your existing home loan with a larger mortgage loan and pays out the difference as a cash-back. The home equity loan, or a second mortgage, allows you to cash out without a full refinance.

Tips for using an amortization schedule

When you take out an amortized loan, the lender or financial institution often provides you with an amortization schedule. If they don't, you can ask for one. Here are a few primary tips to help you better understand and use the schedule:

Know which payment plan is best

When you take out a loan, you usually know the interest rate and how much you want to borrow. An amortization schedule allows you the flexibility to adjust the term and make your loan work with your budget. For example, if a lender offers you a 15- or 30-year mortgage, it's beneficial to know that even though a 30-year mortgage might cost less per month, it costs more overall because of the additional cumulative interest. You can also create an amortization schedule in a spreadsheet to help you budget.

Understand different amortization methods

It's important to understand the different amortization methods because they affect the amount and composition of your repayments on the amortization table. Here are the three primary amortization methods:

Straight-line: This is the most common method because it requires only simple financial calculations. The monthly repayment, principal amount and interest charges remain the same for the duration of the loan, and lenders often apply this method to intangible assets, such as patents, copyrights and intellectual property.
Declining balance: In this method, monthly repayments remain constant, but how you allocate the principal and interest payments varies. The benefit of the declining balance method is that it settles your loan more quickly by decreasing the principal balance and lowering the interest charges, which makes it a good loan for assets that lose their value quickly, like cars and computer equipment.
Annuity: This is a method that requires consistent installment payments over equal time intervals, and differences in each type of annuity can cause slight changes to the amortization schedules. Financial institutions seek payments as an ordinary annuity, which requests payments at the end of each loan period, or an annuity due, which requires payment at the beginning of each loan period.

Be aware of additional or hidden costs

Some amortization schedules don't list all the additional charges that you pay on your loan. When creating or reading an amortization schedule, it's important to research any additional fees included to better plan your finances and prepare for repayments. Some additional fees to consider are:

Origination costs
Closing fees
Early payment penalties
Property tax
Mortgage insurance

This article is for informational purposes only and does not constitute financial advice. Consult with a licensed financial professional for any issues you may be experiencing.