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The process of spreading out any kind of loan into a series of payments that are fixed is known as amortization. Although the monthly payment remains the same as previous, the payments are made in parts that keep changing with time. A certain amount of every payment goes into repaying a part of the interest costs which reduces the loan balance.
The final payment will clear the outstanding amount that has been remaining from the loan. The best way to understand how this works is with the help of an amortization table which also helps in the prediction of the outstanding balance at any particular point in time.
Now let’s take a look at what exactly an amortization table is
The schedule that lists down the monthly payment and the amount that goes into interest with every payment made with respect to the principal amount is what exactly the amortization table depicts. Listed below are some of the common information that are generally maintained in the amortization table:
Every monthly payment is listed individually month-wise for the entire duration to cover the loan amount.
After the interest charges are applied the remaining amount of the payment is utilised to pay off the debt.
A certain amount from the scheduled payment goes into the payment of the interest. This amount is calculated by the multiplication of the remaining loan amount with that of the monthly interest rate.
A point to be noted here is that even though the total amount of the payment will remain equal, the loan interest and principal amount will be different for every month. During the initial period of the loan the interest rates will be the highest and as the time passes on, more amount of the payment goes in the principal and you will have to pay in a proportionately less amount in terms of the interest for every passing month.
How helpful is this amortization schedule
If you have a clear understanding of the borrowing process, then it will become clear to you that amortization is a very helpful thing actually.
Most of the consumers make the decisions based on the fact that the monthly payment amount is affordable or not. But the interest rates are the best way to measure the actual cost of the particular product or service that you purchase because adding up the interest costs will let you know the real amount. When you go for amortization you will be able to get the clear understanding of the total amount to be paid with the help of the table that would be placed in front of you containing the amortization schedule. It will become easier for you to compare different lenders, choose the accurate duration of the loan and also decide whether or not you need to refinance any existing loan.
How are the amortization loans calculated
The payment in case of amortizing loans are based on the amount of the loan, the rate of interest and the total duration of the loan. All these three things are taken into consideration to decide the amount that you need to pay every month and also the total interest that you are liable to pay.
If you think of lowering the rate of interest then this would lower the amount of payment and help you in saving money. If you just lower the loan duration then you will also be able to lower the payment but in this case you will pay more rate of interest taking the entire duration of the loan into consideration.
What are the types of amortizing loans
In the financial world, there are a number of loans that are available which work in different manners. Any loan that is paid in instalment is amortized and you need to pay the balance until it becomes zero over the course of time with payments that are levelled.
Auto loans are amortized loans of five year or shorter duration that you need to pay in fixed monthly instalments. If the long duration is longer then you will have to pay some more interest.
Home loans that are over 15 to 30 years durations are known as fixed rate mortgages but a majority of the people do not keep the loan for that long duration because they either sell the house or refinance the loan.
Personal loans taken from a bank or an online lender or a credit union is generally an amortized loan with approximately 3 year duration, with a fixed rate of interest and monthly payment.
Exceptions to amortization
Credit cards cannot be amortized because you can borrow on a repeated basis on the same card and there is an option to choose the amount that you want to repay for every month and this is why these are termed as revolving debts.
Interest-only loans cannot be amortized initially
Balloon loans have they need to pay large principal amounts at the end of the duration of the loan and therefore cannot be amortized.