Amortization
In commercial real estate, amortization refers to a method of loan repayment in which both principal and interest are included in each monthly payment. Amortizing a debt thereby reduces the balance of a loan to zero by the maturity date on an established schedule. This is opposed to an interest-only loan where each payment consists only of interest payments and a single balloon payment due at the end of the loan period.
Whether a commercial property has a fixed-rate mortgage or an adjustable-rate mortgage, each loan will fully amortize at the end of the term. Common amortization periods for commercial real estate assets are 20, 25, and 30 year periods.
With mortgage payments, most of a monthly payment is allocated towards paying off interest in the beginning of the loan term. As time passes, a greater percentage of the monthly payment goes towards the principal balance. Over the life of the loan, the entire principal will be paid back.
For example, on a 25-year, $2,500,000 loan at 3.75%, the first monthly payment of $12,853.28 would be allocated as $5,040.78 to principal and $7,812.50 to interest. On the last month, the payment would be allocated as $12,813.24 to principal and $40.04 to interest. Investors and commercial property owners that have shorter term loans will pay less interest over the life of the loan because they amortize over a shorter period of time.