What is a Partially Amortizing Loan?
Essentially all loans, unless they are paid back in one payment, amortize in one way or another. There are two main types: fully amortizing and partially amortizing.
Many of us are familiar with fully amortizing loans, but not all loans are fully amortizing. Partially amortizing loans are not especially common in the home loan market, but they do exist. In this article, we’ll look at these loans in detail.
What’s Amortization?
Amortization is another way of describing a loan that the borrower pays back in installments over time. Whether a loan is fully amortizing or partially amortizing, borrowers make payment installments throughout the entire term of the loan. For example, a fixed-rate, 60-month fully amortizing loan will have 60 equal monthly payments.
Each of the 60 payments will apply some funds to the principal of the loan and some to interest. Most of the early loan payments go primarily to interest. As the loan period moves along, more of the monthly payment goes to the principal of the loan. This assumes no extra payments have been made over the loan term.
What’s the difference between a fully amortizing and partially amortizing loan?
With a fully amortizing loan, the borrower makes payments according to the loan’s amortization schedule. The borrower pays off the loan by the end of the loan term. If the loan is a fixed-rate loan, each fully amortizing payment is an equal dollar amount.
On the other hand, a partially amortizing loan is another amortization-based payment schedule, except the entire payment isn’t amortized. Instead, there is a set period of time where an amortizing payment schedule is applied to the repayment of the loan. This can be any portion of the loan term (typically 7 – 9 years).
Once the amortized period ends, payments on the loan can still be made monthly. However, partially amortized loans utilize payments that are calculated using a longer loan term than the loan’s actual term. With these loans, the remaining balance of the loan is due at the end of the amortization period.
Pros and Cons of Partially Amortizing Loans
Benefits of a partially amortizing loan
There are a few benefits, most of which are geared toward for-profit mortgages. These loans often have low monthly payments and a short period of time in which installments are meant to be paid. Upfront, borrowers with partially amortized loans save tons of money.
Drawbacks to a partially amortizing loan
The downside is the balloon payment required to pay off the loan is much larger than most can afford to pay. Partially amortized loans work best when the investment makes a profit. Those funds can then cover the required balloon payment at the end of the loan term.
Because of this, making all monthly payments on a 60-month loan for 60 months straight will not pay the entire balance. Partially amortized loans are designed to include a balloon payment at the time of the loan’s maturity date. The partially amortized loan balloon payment must be paid in full, or the borrower defaults on the loan.