What You Should Know About Loan Amortization

Amortization text on blackboard with businessman on side
Loan amortization means paying off your balance over time through regular payments distributed over a certain period of time. The term is generally associated with paying off loans, however, amortization has wider applications in accounting terms and can be applied to a wide range of balances. Each monthly payment for your home or auto loan may appear to be the same. However, it never is and is made up of several parts, which change over time. As you reduce your loan balance, also referred to as loan principal, the interest rates, which are initially very high, come down gradually, resulting in lesser interest payments for each month.

Loan amortization for long-term loans would generally include high-interest costs at the start and, as more and more amount goes into your principal over time, the cost comes down significantly. The time period is specified prior to the amortization process and is designed in a way that you completely pay off the debt within the specified period.

Showcasing the True Cost of Borrowing

An amortization table will highlight each and every payment you have to make in order to pay off the debt. The table highlights a starting balance, ending balance, a fixed payment amount you have to make each month, a principal amount that is calculated by subtracting the ending balance of each month from the starting balance, and the interest payments which would decline every month.

Instead of focusing on monthly payments because they are going to remain the same, a loan amortization table can help you calculate the exact amount of interest that needs to be paid. Typically, people base their decisions on the amount of the monthly payment, however, the real cost of borrowing is more accurately determined through interest costs that are usually stretched over a long period of time. Therefore, if you want to evaluate the true costs associated with a loan, you must always consult an amortization table.

Loan Amortization helps in Decision Making

Deciding on which loan to choose can get tricky as it can be hard to assess each lender’s terms. Interest rates or shortening the payment span can greatly influence the amount you could end up paying. There are also ways to skip interest charges on loans if you make early payments. It will always pay off if you lay your decision on solid information rather going with an offer that simply sounds good. Amortization of the loan ensures that you are offered the detailed information of each and every payment so you can plan accordingly. Loan amortization simply makes decision making a lot easier.

How to Amortize Loans

There are many ways to create amortization tables. You can build one for yourself or use an online calculator that can easily create one for you. The online option is more convenient and reliable for loans that span over a long period of time. Figuring out how the table works is simple math. The payment is centered on the amount of the loan, the interest rate, and how many years the loan lasts. Those three ingredients work together to affect how much you pay each month and how much total interest you’ll pay. As you lower the interest rate, the payments will also decrease. Stretching out the loan over a longer duration would lower the payments, however, you end up paying more interest. All values basically work in response to one another.

Types of Loan Amortization

Auto Loans

Auto loans are usually 5 years or shorter and are often paid through fixed payments. Because the loan is not a huge amount of money compared to other types of loans, buyers prefer to pay them in equal payments without stretching them out and raising the interest costs.

Home Loans and Mortgages

This kind of loan is spanned over longer time periods, such as 15 or 30 years. People generally tend to refinance these types of loans at some point.

Personal Loans

Credit unions, banks, and online lenders offer personal loans at fixed interest rates that are to be paid back within a specific time period. A loan amortization must be done for all kind of personal loans to ensure that you can plan ahead for future payments.

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