Amortization

Amortization is the process of paying down a loan's principal balance over time through scheduled payments that include both interest and principal. Commercial loans commonly use amortization periods of 25 to 30 years even when the loan's actual term is much shorter (5–10 years), meaning the loan matures with a remaining balance still owed, known as a balloon payment.

Formula: Monthly Payment = Loan Amount × [i(1+i)^n] ÷ [(1+i)^n − 1], where i = monthly rate, n = number of payments

Amortization schedules determine how each payment splits between interest and principal reduction over the life of a loan. Early in an amortization schedule, the vast majority of each payment goes toward interest because the outstanding balance is largest; as the balance shrinks, an increasing share of each payment goes toward principal, a pattern that accelerates toward the end of the schedule.

In commercial real estate, it's standard for the amortization period (used to calculate the monthly payment) to be longer than the actual loan term (when the balance comes due). A 10-year loan with a 30-year amortization schedule, for example, gives the borrower a lower monthly payment than a fully self-amortizing 10-year loan would, but leaves a large balloon payment due at maturity that must be refinanced or paid off.

Longer amortization periods improve DSCR (lower annual debt service against the same NOI) and improve near-term cash flow, but result in slower equity buildup through principal paydown and a larger balance still outstanding at any future refinance or sale point.

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