- 16 Jun 2021
- Finance - BizAv
Deciding to purchase a plane is ill-advised without a clear understanding of a loan’s term versus its amortization.Back to Articles
Amortization is the length of time it takes a borrower to repay a loan. Term is the period of time in which it’s possible to repay the loan making regular payments. Term, therefore, is a portion of the loan amortization period. Consider it the length of time in which one is committing to doing business with the lender.
Most people are used to or conceptualize that a loan’s term and its amortization are coterminous — that when the term is done, the amortization is also done. That’s not always the case. More importantly, that’s not always in your best financial interest.
Frequently, banks offer loans where the term is shorter than amortization. When the two are not coterminous, the loan is said to have a balloon — common parlance for the remaining principal owed at the end of the term.
At the end of the term, the borrower has three choices-refinance with the existing lender, finance externally with a different lender, or pay it off. Most people choose options #1 or #2 to avoid the balloon.
Option #3 — paying it off — can present two ways. The first is when the borrower pays off the debt; the second is when the borrower sells the plane.
Part of your decision must include a thorough understanding of how long you intend to keep the loan - not how long you’re going to keep the plane.
If you’re uncertain about how long you plan to keep the loan, we might advise seeking a shorter term loan at first.
In a shorter-term loan, the cost of money is cheaper than it is in the long term. For instance, ten-year money costs more than five-year money. One note: The more technically advanced the aircraft typically the shorter the amortization.
Also, lenders tend to favor shorter-term loans, particularly on bigger-dollar deals. That’s because banks know a lot can change in five years. They’d rather look at a loan every five years to reassess the risks.
Additionally, revisiting a loan every five years provides a bank an opportunity to look at the borrower’s financials. Are things going better? Worse? The same?
At AOPA AAF, we’ll also discuss with you the efficacy of floating vs. fixed interest rates. In this current environment, for instance, where interest rates will remain flat for some time or may potentially go down, a floating rate can often be a better option.
In all cases, by trying to get a longer term and/or a longer fixed interest rate period — either/or — it’s going to cost you more in interest over the long term. But it will also cost you more money when the amortization is longer because you have principal outstanding for a longer period. Bottom line: The more quickly you pay down the principal, the less you pay in interest.
Great Advice. Great Rates. All From Helpful and Responsive Reps you can Trust!
These are three good reasons to turn to AOPA Aviation Finance when you are buying an airplane. If you need a dependable source of financing with people who are on your side, call 800.62.PLANE (800.627.5263), or click here to request a quote.