We have all, at one point or another, been in need of a loan – be it personal loan, auto loan or home loan in order to meet expenses that are viable only by spreading payments over sufficient time.
All debts and loans have three definitive components:
- The Principal Amount
- The Interest (what the lender gets paid for giving you the loan)
- Time (duration of the loan)
It is important to understand how the repayment of the loan works and what the term “Loan Amortization” means.
The term amortizing comes from the French word “amortir”, meaning the act of providing death- in this case, of killing your debt.
Very simply put, loan amortization is a schedule that enables you to repay two components of your loan, the principal amount and the interest amount, within the third component : a specific time frame. In other words, a planned and systematic repayment of a loan.
The most important amortization formula is the calculation of payment amount per period.
First, the current balance of the loan is multiplied by the interest rate applicable for the current period to find the interest for the period.
A loan amortization calculation basically factors in
- principal amount due
- the interest to be applied for a payment periodicity
- and the amount to be paid to cover both.
Prior to taking the loan, loan amortization calculators can help you decide the term of the loan. And adjust it so you can comfortably afford the periodic payments. However, the longer the term of the loan, the higher will be the interest outflow during the entire loan tenure.
This means that though your monthly payments will be lower, the more interest you will eventually end up paying and the longer your principal debt takes to get paid off.
A simple interest calculation will help you figure out how much interest you will be paying.
Interest = Principal X Interest Rate X Time
Once the term and interest rate have been factored in, the amortization schedule tells you how much of each and every payment is going towards repaying the principal amount and how much towards the interest amount until the loan is paid off.
The initial repayments entail the maximum amount going towards interest repayment and only a marginal amount towards principal repayment. This means that during the initial period of the loan tenure. The payments are going primarily towards paying off the interest. The principal only reduces marginally.
However, since the interest portion of the payment is calculated on the principal outstanding, with each payment the interest component reduces. This is because the principal amount reduces, even if only marginally.
Hence, a greater amount is available to go towards
Thus, the last loan payment will primarily pay off the final principal amount remaining on your debt.
There are a variety of free loan amortization calculators and amortization tables available online that can help you plan your purchases and cater for your repayment schedules.