What exactly does Amortization mean?

Amortization is the process of reducing the estimated or nominal value of either an intangible asset, in case of an enterprise, or a loan, in case of an individual. This is done with the use of an amortization schedule, which is a structured payment method such as an Equated Monthly Instalment (EMI).

How does amortization work?

With an amortized home loan, the debt is paid off entirely by the end of the loan’s term with the help of an amortization schedule that involves EMIs. A fixed repayment schedule is set during which the duration and break-up of loan repayment is clearly stated. Along with this schedule, the loan amount, interest rate, and payment distribution is provided.

What is payment distribution?

At the beginning of an amortized loan, a higher percentage of your ‘monthly repayment amount’ goes towards the interest. This is quite common with long-term loans, where a majority of your periodic payment is an interest expense and a small portion is used to pay off the principal amount. In time, the payment towards the principal increases and you pay a lesser interest amount.

What are the benefits of amortization?

1. The investment risk is comparatively low.
2. Repayment schedule is fixed.
3. Principal payments increase over time.

Why should you opt for amortization?

Imagine repaying a loan without a schedule of payment. What if you had to make a lump sum principal payment at the end of your loan maturity? Practically, it would not be feasible for you to make large payments in a short period of time. The matter is different when a small credit card payment is involved, but once you amplify it to a home loan or a car loan, it will impact cash flows.

A dent in savings could delay life goals and personal milestones for years. Amortization helps you manage large loan repayments so you can plan your finances better. This system of repayment prioritises how your loan is managed.

While opting for a loan, ensure that you choose it to be amortized so that you face no surprises while repaying it.

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