The ABCs Of Amortization

The ABC's of Amortization

Amortization is a term that you don't hear all that often but it is something we have all done at one point of a lives or another. In fact many people are doing it right now. Amortization is when you periodically pay off a loan. This could be anything from a car, goods or furniture. Paying a mortgage on your own home is a form of amortization and interestingly enough they both have "˜mort' within them (a"˜mort'ization and "˜mort'gage) which means to kill "" which fits perfectly for these terms as it is exactly what you are doing. You are paying off your loan until it has been eliminated "" killed, dead, no more or however else you want to put it.

The process of amortization is an easy one to understand once you know the basics and get the idea of how it all works. It is the process of paying off your loan through a set number of periodical payments. A typical payment is calculated by the whole of your loan or principle, the amount of months/payments you have to pay it back and the interest rate.

So for example if you bought a home worth $150,000 and you put down $20,000 deposit you are left with your principle of $130,000. You will need to get a loan for this amount and pay this bacl monthly over 30 years with the interest rate of 7%

So you would work out your monthly payments like this:

Divide your principle (the amount of your loan) which is $130,000 with how long you have to pay it off. In this case it would be 30 years or 360 months, and then you add your interest of 7% to your monthly payments. This ends up to be around $865.00. This would be your monthly payments.

Another thing you should know with amortization loans is that you pay off the interest first then whatever is left comes off your principle loan. But understand, this isn't an interest only loan, as you do pay off parts of your principle in the same payment. For instance with your first repayment of $865.00, approximately $758.00 of that will be interest and $107.00 will be coming off your loan amount. This will take your loan to $129,893.00, but as your loan payments go on your amount of interest in each payment will go down. The amount you are paying off of the actual principle will go up. For another example your two hundredth payments will be like this, your interest out of the $865.00 will be about $526.00 and the amount coming off of your actual loan will be $339.00. This will bring your loan down to $89,806.00. Can you see the difference from your first repayment?

As you continue to pay your repayments, your principle amount will be outweighing the interest amount to look something like this: When you make that 300th payment of $865.00, the interest amount will be $258.00 and the amount coming off your loan will be $607.00 taking the total of your loan to $43,682.00. With your second to last payment your interest amount out of the monthly repayment will have dramatically dropped to $10.00 while your principle payment would have risen to $855.00

As you can quite clearly see the significance of each payment greatly changes as you get further and further on in your repayments. You start out paying mostly interest and in the end the majority of the monthly payment goes toward cutting down your initial loan amount.

Amortization is a delicate process of numbers which would take quite some time to figure out on your own so luckily there are many amortization calculators free to use on the internet. Use these to help you work out your monthly cost on a loan before you decide that this type of loan is for you. This will help you to know if it will fit into your budget smoothly or not. When going for loans many times there will be an accountant who will work all of these figures out precisely for you and some even give you a table so you know exactly where your money is going each month and whether it is off of interest or your actual loan.