Amortization is the process of spreading a loan into payments that consist of both principal and interest over a set timeline, called an amortization schedule. While some commercial real estate loans are fully amortizing, not all are. For example, balloon loans are typically only partially amortizing. In addition, interest-only loans (like many commercial construction loans) usually have a non-amortizing interest-only period, followed by a period that is either partially or fully amortizing.

Amortization affects a commercial real estate loan by reducing the amount of interest a borrower pays as they pay off the principal. In an amortized loan, the amount of interest a borrower pays decreases as they pay off the principal. This is because the amount of interest charged is based upon the most recent principal balance of the loan. As a borrower continues to pay off their loan, the proportion of the payment that goes to interest decreases, while the proportion that goes to paying off the principal increases.

However, many commercial real estate loans are not fully amortizing. For example, a loan might have a term of 7 years and an amortization period of 30. That means that, while the borrower makes payments as if the loan was due in 30 years (over a 30-year amortization schedule), the full principal balance of the loan is due in 7 years. In many cases, commercial real estate borrowers refinance the loan at this point instead of making a large balloon payment.

The main benefit of a traditional amortizing loan is that your monthly payments will remain consistent throughout the life of the loan. This can make budgeting and cash flow planning much easier. Another benefit is that, because you're paying down the principal balance over time, you'll eventually build up equity in the property. This can be beneficial when you refinance or sell the property.

For more information, please see The Benefits and Risks of Interest-Only Loans in Commercial Real Estate and Amortization in Commercial Real Estate.

The main drawback of amortizing a commercial real estate loan is that the loan may be negatively amortizing. In this case, a borrower isn't even fully paying the interest on the loan. Negatively amortizing loans can be particularly risky for borrowers, since each time a borrower doesn't fully pay off a month's interest, that unpaid interest is added to the principal of the loan. The next month, the borrower is required to make a larger interest payment on the new, increased principal. In this case, compound interest actually works against them. In the long run, this can become extremely expensive.

Another drawback of amortizing a commercial real estate loan is that the loan may have a balloon payment. For example, a loan might have a term of 7 years and an amortization period of 30. That means that, while the borrower makes payments as if the loan was due in 30 years (over a 30-year amortization schedule), the full principal balance of the loan is due in 7 years. In many cases, commercial real estate borrowers refinance the loan at this point instead of making a large balloon payment.

You can calculate the amortization of a commercial real estate loan using our Commercial Mortgage Calculator. This calculator will help you determine the estimated principal, interest, and amortization for any given loan amount and rate. The principal is the amount of money you are borrowing from the lender. The loan term is the duration of time that you have to pay off the principal and interest of the loan. Loan terms for commercial properties are usually about 15-30 years. The length of the loan term affects the size of your monthly installments, as well as how much you would have paid off at the end of the loan (your balloon payment).

Commonly associated with amortized loans are balloon payments. Balloon payments involve the borrower paying off the principal with decreasing interest amounts, leaving a large (balloon) payment of mostly principal towards the end of the loan term. Balloon payments should always be planned for, as they can deal quite a blow to your finances if not budgeted for.

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