Amortizing Loans vs. Non-Amortizing Loans

During the early years of the loan, the payment is primarily interest, as the principal outstanding is large. However, in the later years the payment is mostly principal.

Amortizing loans can usually be prepaid without penalty, so prepayment rates must be calculated for an ABS bond supported by amortizing loans.

Non-amortizing Loan

In a non-amortizing loan, the borrower does not have a schedule of payments to repay the debt, rather the borrower is only required to make minimum monthly payments. This is the common structure of a credit card in the U.S. Other examples are balloon mortgages and deferred interest programs.

When the borrower makes a periodic payment that is less than the accrued interest, the balance of the unpaid interest is added to the debt principal.

When the borrower makes a periodic payment that is greater than the accrued interest, the excess balance is applied to reduce the debt principal.

Since a non-amortizing loan has no determined repayment schedule, there is no clear definition for “prepayment”.