If you're looking into different loan types, you might come across the term partially amortized loan. Understanding this type of loan is key if you're considering options that give you more flexibility in monthly payments but might involve a larger financial commitment down the line.
Whether you're a first-time borrower or you’re looking for creative financing options, here you’ll get a complete overview of this financial product.
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What amortization means
Amortization refers to the process of gradually paying off a loan through regular, scheduled payments.
What are the two types of amortized loans? There are fully and partially amortized loan types.
With a fully amortized loan, the borrower makes monthly payments consisting of both principal and interest, ultimately paying off the loan by the end of its term. The loan is structured so that by the last payment, the borrower owes nothing further, and the debt is cleared.
Examples of fully amortized loans include most traditional mortgages, auto loans, and personal loans. Each payment chips away at the principal while also covering the interest owed, so that there’s no remaining balance once the term is over.
What is a partially amortized loan? Definition
A partially amortized loan follows a different structure. While it still involves monthly payments of principal and interest, the loan isn't fully paid off by the end of the term.
The last payment in a partially amortized loan is called balloon payment: A large lump-sum payment. This payment covers the remaining balance of the loan that wasn't paid off through the regular installments.
This structure can lower monthly payments during the loan term but requires you to prepare for the significant balloon payment at the end.
How to calculate partial amortization? For example, if you take out a partially amortized loan with a 10-year term, you may make regular payments based on a 30-year amortization schedule. However, after 10 years, a balloon payment will be required to cover the remaining principal.
How to calculate partially amortized loans (with example)
Calculating a partially amortized loan involves determining the regular monthly payments (which are based on a longer amortization schedule) and the partially amortized loan balloon payment that will be due at the end of the loan term.
First, understand the main loan details and terms:
- Loan amount (principal): The total amount borrowed
- Interest rate: The annual interest rate
- Amortization period: The time over which the loan would be fully paid off (often 20-30 years)
- Loan term: The time over which the loan is structured (often shorter than the amortization period, like five to 10 years)
- Balloon payment: The lump sum due at the end of the loan term (what remains after regular payments)
Second, you have to use the partially amortized loan formula to calculate the monthly payment on an amortized loan:
Where:
- M = Monthly payment
- P = Principal (loan amount)
- r = Monthly interest rate (annual interest rate divided by 12)
- n = Total number of payments (amortization period in months)
Once you know the monthly payment, you can calculate how much of the principal remains after the loan term ends. To do this, you need to determine how much of the loan has been paid off by the time the loan term ends. The remaining balance is the balloon payment.
Partially amortized loan: Example calculation
Let’s go through a quick example to demonstrate how you can calculate a partially amortized loan.
- Loan amount (Principal): $200,000
- Interest rate: 5% annually
- Amortization period: 30 years (360 months)
- Loan term: 10 years (120 months)
Convert the annual interest rate into a monthly rate:
Monthly interest rate = 5% / 12 = 0.004167
Next, calculate the monthly payment using the amortization period (360 months). In this example, the monthly payment is $1,073.64.
Now, calculate how much principal will be left after 10 years (120 months): After 10 years of making monthly payments, the remaining balance (balloon payment) is $162,422.90.
Summary of calculations:
- Monthly payment: $1,073.64
- Balloon payment after 10 years: $162,422.90
You can use a financial calculator or an online partially amortized loan calculator like Omni or Newtum, to streamline these calculations. Many websites allow you to input the loan amount, interest rate, loan term, and amortization period to get the monthly payment and balloon payment with ease.
Fully amortized loan vs partially amortized loan: Differences
What is the difference between fully and partially amortizing? The most significant difference lies in the repayment structure.
Fully amortized loan:
- Monthly payments are higher because they are structured to pay off the loan's entire balance by the end of the term.
- No balloon payment at the end of the loan term.
- Ideal for borrowers who prefer steady, predictable payments and want to fully clear the debt by the end of the term.
Partially amortized loan:
- Monthly payments are lower since they cover only part of the loan’s balance during the term.
- A large balloon payment is required at the end of the term.
- Suitable for borrowers who need lower monthly payments but expect to have the funds or refinancing options available to cover the balloon payment.
A partially amortized loan offers more flexibility in the short term but shifts the burden of a large payment to the end of the loan. This trade-off can be helpful for some borrowers, but it also presents significant risks if you're unable to make the balloon payment when it becomes due.
Pros and cons of a partially amortized loan
Wondering what is an advantage of a partially amortized loan? Like any financial product, they come with both benefits and potential drawbacks.
Pros:
- Lower monthly payments: Since the loan is only partially amortized, the monthly payments are typically lower than those of a fully amortized loan. This makes it easier for borrowers who need more manageable monthly expenses.
- Flexibility in cash flow: The reduced monthly payments provide more room in your budget, allowing for investments or covering other expenses.
- Useful for short-term ownership or investment strategies: If you plan to sell or refinance the property before the balloon payment is due, a partially amortized loan can be a good option since the large payment won't need to be addressed immediately.
- Potential to refinance: If interest rates drop, or your financial situation improves, you may be able to refinance before the balloon payment is due, avoiding the large one-time cost.
Cons:
- Balloon payment risk: The most significant disadvantage is the balloon payment at the end of the loan term. If you're unprepared for it, you may find yourself scrambling to pay a large sum of money.
- Interest cost over time: While the monthly payments are lower, you may end up paying more in interest over time compared to a fully amortized loan. This is because you're paying off less of the principal during the term.
- Limited flexibility if markets change: If the market changes or your financial situation worsens, refinancing or selling the property to cover the balloon payment may not be possible.
- Not ideal for long-term borrowers: If you plan to hold the property for a long period, the balloon payment may be a significant burden, making a fully amortized loan a better choice.
A partially amortized loan can offer benefits like lower monthly payments and flexibility in cash flow, making it attractive for short-term investments or specific financial strategies. However, it also carries the risk of a large balloon payment at the end of the term, which could pose challenges if you don't plan carefully.
If you're considering this type of loan, have a clear strategy in place for how you'll handle the balloon payment. Whether you intend to sell the property, refinance the loan, or save for the lump-sum payment, preparation is key to avoiding financial strain.
FAQs
Which repayment plan is a partially amortized loan?
A partially amortized loan uses a repayment plan where the borrower makes regular monthly payments based on a longer amortization period than the actual loan term. At the end of the loan term, there is a remaining balance, known as a balloon payment, that must be paid off in a lump sum.
What is another term for a partially amortized loan?
Another term for a partially amortized loan is a balloon loan. This refers to the fact that a large payment (the balloon payment) is required at the end of the loan term to pay off the remaining balance.
What happens if I can't make the balloon payment on a partially amortized loan?
If you're unable to make the balloon payment, you could face serious consequences, including foreclosure or repossession of the collateral (such as a home or car). However, many borrowers refinance the loan or sell the property to cover the balloon payment before it becomes due.
Can I refinance a partially amortized loan?
Yes, refinancing is an option many borrowers consider before the balloon payment is due. This allows you to avoid the large lump-sum payment and possibly secure better terms, depending on the current interest rates and your financial situation.
Are partially amortized loans common for mortgages?
Partially amortized loans are less common for residential mortgages but may be used in specific investment or commercial property scenarios. Homebuyers typically prefer fully amortized loans to avoid balloon payments.
Is the balloon payment amount fixed?
The balloon payment is determined by the remaining balance of the loan. The more of the loan’s principal that has been paid off during the term, the smaller the balloon payment will be.