Amortization is, “the systematic repayment of a debt”. The emphasis is on the word “systematic”. Amortizing a loan means paying it down, bit by bit. Usually this means making regular monthly payments, and this is what is done for home or car loan.
The great advantage of amortization is that you know how much you have to pay each month, under a fixed interest rate, to finish paying off the loan at a specific time. You can work out an amortization table to show each payment.
Amortizing a Home or Car Loan
When you take out a home/car loan, you make a monthly payment to the lender (usually a bank from which you have taken a loan), and that is an amortization payment. A part of the payment covers the interest payable on the loan, and the remainder of the payment goes to reduce the principal amount owed. Interest is computed on the current amount payable and thus will become progressively smaller as the principal is decreased.
Example:
If have taken a home loan of 8 lacs with 11% interest rate for 20 years.
Considering: Loan started on Jan 1st, 2015
Long loan tenure has large interest payments and small payments to the principal, leading you to pay many times more than your loan amount. As time goes on, you will reduce the principal to the point that you haven’t got much to pay in interest, and so your payment covers mostly the principal.
In above example you can see
Loan amount– 8 lacs
Interest payable– 11.81 lacs
Total Payment (Principal+Interest) – 19.81 lacs- It is more than 2 times the loan amount.
Loan Amortization helps you to decide on how long loan tenure you should opt for and save more on paying interest.
In this case, it is recommended to either shorten the loan tenure or pay off the loan whenever you have a lumpsum amount.
Moneyfrog.in has launched version 2.0 with new exhilarating features and Loan Amortization is one of them. You can find it in your account’s “my financial info”.
Data Source: http://www.calculator.net/