Amortization is the breaking down of a loan into a batch of fixed payments over a period of time. The interest and principal amount of a loan can vary each month but that has to be paid off even though your overall payment is equal for each period. Amortization is an accounting word that can be used for other balances as well such as allocating certain costs over a lifetime for an intangible asset.
In this, each payment of yours will go toward the interest costs, i.e., the amount that your lender will be paid for your loan, and reducing the loan balance, which is basically paying off the loan principal.
However, the process needs patience because initially there is hardly any progress on the principal repayment of the debt. In this case, having a detailed picture of your loan’s components is critical. It helps you see how much you have to pay in interest rather than the monthly payment. Both of them do not go necessarily hand in hand often.
Amortization is unique in the sense that it is one of the easiest calculations a borrower can make themselves (whether they are an accounts professional or not) beforehand to be prepared to decide which loan and for how long should it be taken. To create an amortization table, it can be done through building your own by hand, an online calculator or spreadsheets that assist you in analyzing loans and create amortization schedules.
The steps to be taken in making an amortization table are as follows:
- Know your starting loan balance
- Calculate your monthly payment
- Calculate the interest to be paid on a monthly basis
- Subtract the monthly payment and interest to determine the principal amount per month
- Subtract the loan balance from the principal amount
- Start again in the months to come
When it comes to loans, amortization is of several types:
- Home loans
They are usually 15-30 year mortgages at a fixed interest rate. However, many people do not wish to keep a loan pending for that long and instead sell the home or refinance the loan at one point. However, if you are smart enough in your calculations, it can work well for you as you can consistently keep paying off the same amount till the entire term. - Personal loans
The loans that one is generally offered from a bank, credit union, or an online moneylender are essentially amortized loans too. They are often useful for extremely small-scale or low-budget projects and debt consolidation. They are kept very simple, having a time period of three years with fixed interest rates and monthly payments. - Auto Loans
