When you take a business loan, you’re borrowing a set amount of money (the loan amount), paying a predetermined interest rate, and making a certain number of payments. The amount of total interest you pay with each payment falls over the course of a loan while the amount of principal you pay rises with each payment. An amortization schedule helps you understand where your payment is applied for each payment.
What is Loan Amortization?
Loan amortization is the structural organization of a loan, where you pay the principal down each month over a set period of time. The amount of principal you pay each month isn’t the same because as you pay off the loan, you pay less in interest and more towards the principal.
The amount that you pay each month is broken into a set number of payments of equal amounts. Even though your monthly payment amount doesn’t change, it’s beneficial to know how much of the payment applies to the principal and how much to interest.
How To Calculate A Business Loan Amortization Schedule
To calculate your loan amortization schedule, you need to know your monthly payment. Follow these steps to determine your schedule:
- In the first month, multiply the total amount of the loan by the interest rate of the loan.
- If your loan is monthly, divide the results from step one by 12.
- Now, you have the amount that you pay in interest each month.
- Subtract the amount of monthly interest from the monthly payment to find how much principal you pay each month.
This is a simple schedule, and you need to follow these steps for each month of the loan because your principal becomes less each month as does the amount of interest. You can also use a business loan calculator to estimate how much you will pay each month for your small business loan.
Interest Rate, Compound Period, and Payment Period
Interest rates stay the same throughout the loan. However, as you pay the loan, you pay off more of the principal, so the amount of interest that you pay in each payment period becomes lower.
A compound period is the time period that passes before interest is compounded again, typically a year. The payment period is the period of time from when you when borrowed the money until you pay it back in full.
Rounding is done when you have a fraction of a percent or a penny. For example, if the interest payment is calculated to be $22.364. You can’t make a payment for four-tenths of a penny. You need to round it up or down.
Sometimes, a monthly payment is less than the amount of interest that accused during that period. For example, if your monthly payment is $30 and the accused interest is $35, you have negative amortization.
In some cases, you can make a payment that applies only to the principal or only to the interest. These are almost always extra payments. When you make a principal-only payment, it might lower the number of payments you need to make and the amount of interest you’ll pay over the life of the loan.
A zero balance or non-amortizing loan is a loan that’s paid back in a lump sum at a specific time. This would include both the principal and the agreed-upon interest.
For example, if you borrowed $500 and pay $50 in interest, you would pay the entire $550 back all at once at the specified time.
When you make an extra payment, you’re also shortening the length of the loan but not the number of payments, affecting the loan’s payment schedules. In some cases, you can pay more than your monthly payment and apply the extra amount to either your next payment or the principal that you owe. If you apply it to the principal, you reduce the amount of interest you pay over the life of the loan.
The Types of Amortization Schedules for a Business Loan
There are different types of amortization schedules for a business loan based on the repayment schedule. This schedule can help you visualize how much of your payment goes to interest and how much to the principal. It’s a great way to take control of your finances and help you understand why the payments are for the amount they are set for and how much interest you’re paying over the life of the loan.
Weekly Loan Amortization
If you make weekly payments on your loan, you have weekly loan amortization.
Daily Loan Amortization
With a daily loan amortization, interest is compounded daily. In some cases, even with daily loan amortization, you make payments once a week, so you don’t need to make daily payments. This type of amortization is typically used for loans that only last a couple of weeks to three months.
Monthly Loan Amortization
This is the amortization used by most traditional banks and lenders. Interest is figured on a monthly basis. You’re more likely to see this amortization that spans several years to a decade.
Loans With No Amortization Schedule
Loans with no amortization schedule are generally repaid in a set period of time in one lump payment instead of several loan payments. You agree on the entire amount of interest you’re going to pay without the option to lower the amount of interest by paying early.
Line of Credit
You have a set amount of funds that you can quickly access whenever you need it, and you pay it back on a predetermined schedule according to the repayment terms of the business line of credit.
Invoice Factoring and Invoice Financing
When you need to buy supplies or raw materials, you can find businesses that pay the invoice for you, and you repay the funds after you realize the profit from the invoiced items.
Merchant Cash Advance
These loans are paid back daily based on your daily sales. You don’t have to pay it back in a specific timeframe, but you pay a set amount of interest.
Other Things to Consider on Your Business Loan
When you’re choosing a business loan, you want one that fits your company’s needs. Here are a few things small business owners need to consider:
Your interest rate determines how much you repay the lender. The higher the interest rate means the more money that you pay back. Your credit rating and the type of loan affect the interest rate.
Simple vs. Compound Interest
With simple interest, you pay a flat rate for interest while compound interest means that you pay interest on the interest, especially if your payments don’t cover the amount of interest you owe at the time.
The effective APR is the amount of interest you pay in compound interest over the course of the year.
Annual Interest Rate
This is the amount of interest that you pay on a loan over a period of a year.
Factor rates are a tool used to show the interest rate in decimal form. This is generally used in very short-term loans.
Reduced Interest Payments Over Time
As you pay down the principal, you pay less interest. This is because you aren’t paying interest on as much money as you were initially.
Some loans require a penalty if you pay them early because the lender won’t receive as much interest. Also look out for any other fees on the loan, for example, the loan origination fee.
Extra payments don’t change the amount of interest you pay. It just allows you to pay the loan off early.
FAQs About Business Loans Amortization
Here are some common questions about business loan amortization.
Yes, most business loans are amortized. This is simply a comparison of how much interest and principal that you pay in each payment.
This really depends on the type of business loan. Some loans are short-term loans to be paid off in three months to three years while long-term loans could have terms between five and 10 years.
You can determine the amortization of a business loan on your own, but you’re always better informed when you use a loan amortization calculator on the lender’s website.
As a business owner, it’s essential that you understand the amortization schedule on your loan. This helps you to understand how much you’re going to pay in interest over the loan’s life. You can also see how paying down the principal helps to reduce the amount of interest you pay.