You are a salaried individual, planning to take a home loan to be repaid in fixed monthly instalments. You want the debt completely paid off when you pay the last monthly instalment. So, how do you do that? You figure out a fixed monthly repayment amount in a way that it accounts for both the principal amount and the interest and eliminates your debt over a period of time. So, this process of spreading out the loan to create fixed monthly payments is known as loan amortisation.
When you amortise your loan, you agree to pay a fixed amount every month - a portion of that amount goes towards your interest payments and the remaining goes for repayment of the principal amount. Although your total monthly payment will remain fixed, the parts (interest and principal) that make up these payments keep changing over time. During the early months of the loan, your interest charges would be at their highest. In fact, a major part of your monthly payments during the initial months would be your interest expense, and you pay only a small amount for the principal. However, as months go by, the amount that goes towards repayment of principal keeps increasing, while the interest portion keeps reducing.
Any loan that requires you to make equal monthly payments and brings your debt down to zero with these payments is an amortised loan. Some common examples of amortised loans include:
Assume that you are borrowing S$50,000 for a period of 12 months with 5% p.a. interest (payable monthly). Based on your fixed monthly repayment amount, which can be calculated using the Amortisation calculator, you can find out how much of your monthly payments is going into interest and how much is going into repaying the principal amount. Take a look at the table to understand how amortisation works.
Month | Outstanding Principal (at the start of the month) | Monthly Payment | Principal Paid | Interest Paid | Outstanding Principal (at the end of the month) |
---|---|---|---|---|---|
1 | S$50,000 | S$4,280.37 | S$4,072.02 | S$208.35 | S$45,927.98 |
2 | S$45,927.98 | S$4,280.37 | S$4,088.99 | S$191.38 | S$41,838.99 |
3 | S$41,838.99 | S$4,280.37 | S$4,106.03 | S$174.34 | S$37,732.96 |
4 | S$37,732.96 | S$4,280.37 | S$4,123.14 | S$157.23 | S$33,609.82 |
5 | S$33,609.82 | S$4,280.37 | S$4,140.32 | S$140.05 | S$29,469.50 |
6 | S$29,469.50 | S$4,280.37 | S$4,157.57 | S$122.80 | S$25,311.93 |
7 | S$25,311.93 | S$4,280.37 | S$4,174.90 | S$105.47 | S$21,137.03 |
8 | S$21,137.03 | S$4,280.37 | S$4,192.29 | S$88.08 | S$16,944.74 |
9 | S$16,944.74 | S$4,280.37 | S$4,209.76 | S$70.61 | S$12,734.98 |
10 | S$12,734.98 | S$4,280.37 | S$4,227.30 | S$53.07 | S$8,507.68 |
11 | S$8,507.68 | S$4,280.37 | S$4,244.92 | S$35.45 | S$4,262.76 |
12 | S$4,262.76 | S$4,280.37 | S$4,262.76 | S$17.61 | S$0.00 |
Unamortised loans require you to pay just the interest amount every month, leaving you with the principal amount to be paid at the end of the loan. These loans work best for the people who prefer lower monthly repayments and who can repay the principal amount in lump sum. Some examples of unamortised loans include credit cards, personal line of credit, and balance transfer.
Not all loans are amortised. There are certain types of loans where you pay only the interest, fixed or variable, throughout the tenure while the principal amount is paid back at the end of the tenure in a single payment. Check out some of the most common types of unamortised loans in Singapore:
Negative amortisation is a situation when your monthly payments are not enough to cover the interest that is due for the month, leading to a continuing increase in your principal loan amount. It is possible in case of any type of loan and often leads to a difficult situation where your outstanding amount continues to grow every month.Here’s an illustration to help you understand how negative amortisation works.
Assume that you owe S$50,000 to a lender. Your first month repayment amount is S$300, which includes S$150 as the principal amount and S$150 as the interest. For some reason, you could not pay this amount of S$300, instead you only pay S$150 (which will cover the interest due). So, in that case, instead of your principal loan amount going down, it actually goes up. At the end of the first month, you owe S$50,150 to the lender. This is negative amortisation.
The situation of negative amortisation usually arises when you are simply not in a position to make the monthly payment. It also happens sometimes when one takes a loan to buy an out-of-budget property hoping to have enough income in the future to repay it.
With a partially amortised loan, you pay a part of the principal amount during the tenure of the loan, while the remaining balance is paid at the end of the loan term as a balloon payment. Partially amortised loans could be useful in situations when you can’t afford the monthly payments of a fully amortised loan.Here’s an illustration to help you understand how these loans work.
Assume that you have taken a partially amortised loan worth S$500,000. The term of the loan is 7 years. So, based on the amortisation schedule and rate of interest on the loan, you will pay a certain amount every month for 7 years. After seven years, you will have to settle the entire outstanding balance in a single payment (a balloon payment).