Amortization

An amortizing loan is paid down over time. Each payment covers the interest accrued since the last payment plus a portion of the principal. Early on, most of the payment is interest, because the balance is large; later, the shares reverse. A loan amortized over 30 years has a lower payment than the same loan amortized over 25 years, because the principal is spread across more months.

Commercial real estate loans often separate the amortization period from the loan term. A permanent loan might have payments calculated on a 30-year schedule but come due after 10 years, at which point the remaining balance, the balloon, must be refinanced or repaid. Some loans, especially construction loans, are interest-only and do not amortize at all until they are replaced.

Assume a $15,600,000 loan at 6.5% on a 30-year schedule. The monthly payment is about $98,600. In the first month, $84,500 of that is interest and $14,103 is principal. The principal share grows a little each month as the balance falls.

Amortization matters for rent through the mortgage constant. A shorter schedule raises the constant and the annual debt service a building must cover. Under our defaults, moving from a 30-year to a 25-year schedule at 6.5% raises the constant from 7.585% to 8.10%, and a 40-year schedule lowers it to 7.03%. This is one reason longer-amortization government-backed loans can support lower rents on the same building.