Glossary
Amortization
Amortization is the gradual repayment of a loan's principal through scheduled payments over a set period. Each payment covers interest due and reduces principal, so the interest portion falls over time. The amortization period sets the payment size and may be longer than the loan's term.
Formula
Example
A $1,000,000 loan at 6% interest with a 25-year amortization has a monthly rate of 0.5% and 300 payments. The monthly payment is about $6,443, or $77,316 per year. In the first month, interest is $5,000 ($1,000,000 x 0.5%) and principal is about $1,443. After 10 years, the remaining balance is about $763,520, meaning roughly $236,480 of principal has been repaid.
How it is used in underwriting
Underwriters care about amortization because it affects both cash flow and risk. A longer amortization lowers the annual payment, raising DSCR and supporting a larger loan, but it reduces principal paydown and leaves a larger balance at maturity. A shorter amortization builds equity faster and lowers refinance risk but strains current cash flow. Lenders therefore match amortization to the useful life of the collateral: longer for real estate, shorter for equipment, and often five to ten years for business acquisition loans secured mainly by goodwill and cash flow.
The amortization period and the loan term are different. Many commercial real estate loans have a 10-year term with a 25- or 30-year amortization, leaving a balloon payment at maturity. Interest-only periods delay amortization and should be underwritten on the amortizing payment that follows. In accounting, amortization also refers to expensing the cost of intangible assets such as goodwill or customer lists over time, which is why it appears in EBITDA. The two meanings share the idea of spreading a value over time but are otherwise unrelated, so context matters when reading a credit memo or financial statement.
Typical benchmarks
Commercial real estate loans commonly amortize over 25 to 30 years, SBA 7(a) business acquisition loans often over about 10 years, and equipment loans over the useful life of the equipment.
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Frequently asked questions
What is the difference between amortization period and loan term?
The amortization period is the time over which payments would fully repay the loan. The term is when the loan actually matures. If a loan has a 10-year term and 30-year amortization, payments are calculated as if it lasted 30 years, and the remaining balance is due as a balloon payment at year 10.
Does a longer amortization increase total interest paid?
Yes. A longer amortization lowers each payment but repays principal more slowly, so interest is charged on a higher balance for longer. Total interest over the life of the loan increases. Borrowers trade higher lifetime cost for lower near-term payments and better cash flow.
What is negative amortization?
Negative amortization occurs when a loan payment is less than the interest due, so the unpaid interest is added to the principal and the balance grows over time. It is uncommon in commercial lending today and is generally treated as a higher-risk structure because the borrower's leverage increases rather than decreases.
Related terms
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