What is an Amortization Loan?
Amortization is a fancy word for a fairly simple concept. When it comes to loans, amortization is the paying off of debt with a fixed repayment schedule in regular installments over a period of time. You are most likely to come across amortization with a car loan or mortgage, because you typically pay the same amount of money over a set schedule.
In other words, amortization is the process by which the principal of a loan decreases throughout the predetermined payment period. With an amortization loan, with each payment you make, a set portion goes toward paying down the principal and another portion is used toward interest.
If you have an amortization loan, you will also receive an amortization schedule that details each payment you are required to make. The schedule will detail the ratio of principal to interest and show how the principal of your loan decreases over time. If you fail to pay the full amount of interest one month, the loan amount will actually increase. An amortization schedule that shows an increased loan amount is known as negative amortization.
Since interest is computed on the current amount owed for an amortization loan, the amount of money you put toward interest will become progressively smaller as the balance of the loan is reduced over time. In general, for a mortgage loan, you will be paying a lot toward interest and not as much toward the principal for the first several years of the loan. This type of payment structure will continue until your final payment - when you completely pay off the principal and pay next to nothing in interest.
Amortization Schedule Calculator
Prior to taking out an amortization loan, you can use an amortization schedule calculator to estimate your monthly payments, as well as how long it will take you to pay in full. Since an amortized loan is for one specific amount that must be paid off by a certain date, typically in equal monthly installments, certain forms of debt such as your credit card would not fit the definition. Why? Your credit card payments fluctuate each month and there is no fixed payoff date.
If you plan on applying for an amortization loan, be sure to take a close look at the amortization schedule. You will be able to see how much interest and how much principal is included in each monthly payment, from the first to the last. Knowing this information beforehand is invaluable in terms of figuring out whether you can actually afford a particular amortization loan.