Have you ever heard the word amortization? Most people have done it at least one time in the lives, as a matter of fact there are some people doing it right now, maybe you? Amortization means paying on a loan periodically. Your car payment would be an example or anything else that you took out a loan to purchase. Your home has a mortgage and that is a form of amortization, if you notice they both have the term mort in them and that means to kill. So in fact when you are making your loan payments you are killing off the loan.
Amortization is the whole process of you making periodical payments on your loan with a prearranged number of payments. Typically most loans are based on the same calculations, meaning the entire amount of your loan or principle, the amount of payments necessary to pay it off- usually monthly payments, and the interest incurred on the loan.
For example if you purchased a car for $20,000 and you made a down payment of $5000 you would be left with the principle of $15,000. So your loan would have to be for $15,000 and then you would make monthly payments for 5 years with an interest rate of 5%.
Your monthly payments would look something like this:
First you would divide the entire amount of the loan, $15,000 by 60 months, the amount of time you have to pay it off. For this example it would be 60 months or 5 years now you would add the 5% interest rate to your monthly payment. So in the end this would calculate to $283.07 making monthly payments.
With any amortization loan the interest is always paid first and what is left of your monthly payment will go to the actual principle of the loan. To break it down in money matters, your first payment of $283.07, around $62.50 of your payment will go to pay interest and the remaining $220.57 will go towards the principle of your loan. So now your loan now would be at $14779.43. As time goes on and you continue to make monthly payments the amount for interest goes down and your principle will go up. By the time you reach your 24th payment the interest on your repayment of $283.07 will be at $36.29 and $246.77 will be applied towards the principle. Therefore you can see the decreased interest payment, and the higher amount coming off of the actual loan.
You will be able to see, over the course of time, a dramatic change in the amounts of your loan in regards to paying interest and what goes towards the actual loan amount. As with any amortization loan you begin by paying mostly interest but over time you get to the actual whittling away of the loan amount that you initially took out.
It’s a good thing that you can find amortization calculators on the internet for free to help you balance and understand all these figures and how your amortization loan will work, they are very easy to use. When getting your loan many times you will receive a schedule just like the one we used in the example. Doing research with amortization calculators at your disposal, can be very helpful to see exactly what you are getting into before you even apply for your loan.
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Geoff Spencer is a staff writer at Real Estate Digest and is an occasional contributor to several other webistes, including Online Business Gazette.
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