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Amortizing Loans vs. Non-Amortizing Loans

CFA® Exam, CFA® Exam Level 2, Fixed Income Securities

This lesson is part 11 of 25 in the course Fixed Income Part 2

Amortizing Loan

In an amortizing loan, the borrower makes regularly scheduled payments, called equated monthly installments, over the life of the loan to pay off the debt.  Each payment is consists of part interest and part principal.

The payment every month is fixed and is calculated in such a way that the interest portion of the payment is equal to the interest due for the month on the balance principal outstanding. The remaining portion of the payment is paid towards the principal. As more principal is paid every month, the outstanding principal balance keeps reducing. For this reason, this type of loan is also called a reducing-balance loan.

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”.

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In this Course

  • CFA Level 2: Fixed Income Part 2 – Introduction
  • Mortgage Cash Flow Characteristics
  • Mortgage Pass-through Securities: Characteristics and Risks
  • Cash Flows and Prepayment Risk
  • Single Monthly Mortality (SMM) & Conditional Prepayment Rate (CPR)
  • PSA Prepayment Benchmark
  • Collateralized Mortgage Obligations (CMO) and CMO Tranches
  • Stripped MBS – Interest Only (IO) and Principal Only (PO)
  • Residential Non-Agency MBS
  • CMBS: Structure and Call Protection
  • Amortizing Loans vs. Non-Amortizing Loans
  • Overview of Asset Backed Securities (ABS)
  • Internal and External Credit Enhancements
  • Pay-through Structures: Prepayment Tranching vs. Credit Tranching
  • Home Equity Loans (HEL) Backed Securities
  • Manufactured Housing Backed Loans
  • Auto Loans Backed Securities
  • Student Loan Backed Securities (SLABS)
  • SBA Loan Backed Securities
  • Credit Card Receivable Backed Securities
  • Collateralized Debt Obligations (CDOs) and Synthetic CDOs
  • Cash Flow Yield, Nominal Spread, and Zero Volatility Spread for ABS/MBS
  • Monte Carlo Simulation for ABS/MBS
  • Duration and Convexity for ABS/MBS
  • Choosing an Appropriate Spread for ABS/MBS

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