What is Amortization
This refers to the periodical repayment of loans in a planned manner. These are different from the other normal loans due the manner in which it is structured. For example mortgage loans are very common form of amortized loans. The term “mort” means to slay or do away with the loan through regular period.
The amortized loan is calculated by dividing the principle amount, this is the balance amount the is given as loan after down payment. This is divided by the number of months for which the loan is given. Here interest is added on them. This interest is calculated at the present rate to the time-span for which the loan is taken. This may vary from 10 or 15 or even 20 years. Every payment of loan that is made eliminates a portion of interest along with the principle amount.
Many people have a confusion over amortize loans and interest only loans. The latter is very true and simple to understand by the term. This refers to the periodic payments that goes only towards the interest and not to the principle amount. The borrower can make additional payments if he or she wants to do so towards the principle amount due. Such kinds of loans are advantageous because they allow small repayments.
On the other hand in case of amortized loans larger portion of amount goes in a structured manner towards interest first. After that a portion of amount is paid towards principle. In many cases the amortized loans can take at least half the life of loan term or even more for the principle amount and interest to become equal. After a few years we can realize that the principle amount begins to outwit the amount of interest. Thereby diminishing the balance very quickly.
Sometimes people may prefer to pay extra amount every month, other the structured payments and apply the same amount to the principle balance. Interest is the result of the principle amount multiplied by the interest rate, the borrowers might feel that lower the principle interest rates will also be lowered. Hence they choose the option of paying additional amount every month. By doing this they save money in the longer run and also the term of loan also reduces. Here the borrowers should make it very clear to the finance company that these larger payments made should be applied to the principle amount.
There is also a danger of borrowers going into negative amortization. This may happen if they are paying less than the structured payments. In such cases the loan balance increases and with this increases your loan interest. Hence the borrower must plan every month by earmarking the structured amount that has to be paid towards amortized money or even for that matter any kind of property attached to it.