Amortization is the process of repaying a loan through a schedule of level periodic payments, each split between interest on the outstanding balance and principal that reduces it. Early payments are mostly interest; later payments are mostly principal. In commercial real estate, most loans amortize over 25 or 30 years even when the loan term is shorter.
How Is Amortization Calculated?
Amortization is calculated with the level-payment formula that solves for the fixed payment repaying a balance over a set number of periods at a given rate. The formula is P = L times [r(1+r)^n] / [(1+r)^n - 1], where L is the loan amount, r is the monthly rate, and n is the number of payments. Each payment's interest equals the balance times r; the rest reduces principal.
Per Janover and Commercial Loan Direct, most commercial mortgages amortize over 25 or 30 years, with CMBS loans typically using a 30-year schedule. A longer amortization lowers the monthly payment but increases total interest paid, because principal is retired more slowly. The interest portion of each payment falls over time as the balance shrinks.
Symbol | Meaning |
L | Loan amount (principal) |
r | Monthly interest rate (annual rate divided by 12) |
n | Total number of payments (amortization years times 12) |
P | Level monthly payment of principal and interest |
To build a schedule, multiply the current balance by r to get the interest portion, subtract that from the payment P to get the principal portion, then reduce the balance by that principal before the next period. Repeat for every month.
Why Amortization Matters
Amortization matters because it sets the monthly payment, which drives debt service coverage, and it determines how fast a borrower builds equity through principal paydown. A longer amortization lowers the payment and improves coverage ratios at underwriting, but it slows equity growth and raises lifetime interest. The choice shapes both loan approval and long-term return.
Per Commercial Loan Direct, a $1,000,000 loan at 6.5% amortizing over 25 years carries a monthly principal-and-interest payment of about $6,752, while stretching the same loan to 30 years lowers it but adds years of interest. That payment difference flows straight into the debt service coverage ratio lenders size loans against.
The quotable point for an operator: amortization sets the payment, and the payment sets the coverage ratio, so the amortization period is a lever on how large a loan a property can support.
Example
A borrower takes a $2,000,000 commercial loan at a 6.5% fixed annual rate amortizing over 25 years. The monthly rate is 0.065 divided by 12, or about 0.005417, and n is 300 payments. Applying the formula gives a level monthly payment of $13,504.14.
Component | Month 1 | Detail |
Payment (P) | $13,504.14 | Level, from the formula |
Interest | $10,833.33 | $2,000,000 times 0.005417 |
Principal | $2,670.81 | Payment minus interest |
Balance after payment | $1,997,329.19 | $2,000,000 minus principal |
In month one, $10,833.33 of the $13,504.14 payment is interest and only $2,670.81 reduces principal. The same $2,000,000 loan stretched to a 30-year amortization drops the payment to $12,641.36, easing monthly coverage but leaving a larger balance outstanding for longer. The formula makes the trade-off precise rather than approximate.
Variations and Edge Cases
Amortization behaves differently depending on how a loan is structured. The table below covers the variants an operator should recognize when reading a term sheet.
Variant | Treatment |
Fully amortizing | Payments retire the entire balance by maturity; no balloon |
Partial amortization | Loan amortizes on a longer schedule than its term, leaving a balloon at maturity |
Interest-only period | No principal is paid during the interest-only period; amortization begins after |
Negative amortization | Payment is below the interest due, so the balance grows rather than shrinks |
Straight-line amortization | Equal principal each period with declining total payments, common in some bank loans |
The most common point of confusion is treating amortization as the loan term. Most commercial loans amortize over 25 or 30 years but come due in 5, 7, or 10, leaving a balloon payment. The amortization sets the payment; the term sets when the remaining balance is due.
Amortization vs Loan Term
Amortization is often confused with loan term, and both are stated in years, but they measure different things. Amortization is the period over which the payment is calculated to fully repay the loan. The loan term is the period until the loan matures and the remaining balance comes due.
The practical difference produces the balloon. A loan with a 30-year amortization and a 10-year term makes payments as if it will take 30 years to repay, but the outstanding balance is due in 10, creating a lump-sum balloon payment at maturity. When amortization and term are equal, the loan is fully amortizing and no balloon exists. Confusing the two leads to underestimating the payoff owed at maturity.
Frequently Asked Questions
What is amortization in commercial real estate?Amortization in commercial real estate is the process of repaying a loan through level periodic payments, each split between interest on the outstanding balance and principal that reduces it. Early payments are mostly interest and later payments are mostly principal. Most commercial loans amortize over 25 or 30 years even when the term is shorter.
How is amortization calculated?Amortization is calculated with the level-payment formula P = L times [r(1+r)^n] / [(1+r)^n - 1], where L is the loan amount, r is the monthly rate, and n is the number of payments. Each period's interest equals the balance times r, and the remainder of the payment reduces principal.
What is the difference between amortization and loan term?Amortization is the period used to calculate the payment that fully repays the loan, while the loan term is when the loan matures and the remaining balance is due. A 30-year amortization with a 10-year term makes payments as if repaying over 30 years but leaves a balloon balance due in 10.
Does a longer amortization mean lower payments?Yes. A longer amortization spreads principal over more periods, lowering the monthly payment but increasing total interest paid. Per Commercial Loan Direct, a $1,000,000 loan at 6.5% over 25 years runs about $6,752 monthly, and extending to 30 years lowers the payment while adding years of interest.
Related Terms
Interest-Only Period
Permanent Loan
Debt Service Coverage Ratio
CMBS Loan
Loan to Value Ratio