Simple Guide to Understanding Loan Amortization

What is Loan Amortization?
In regards to economics, amortization refers to the distribution of a single lump-sum cash flow into many smaller installments, as determined through an amortization table or schedule. Amortization is a loan with a unique repayment structure. Unlike other models, each repayment in an amortization consists of satisfying both the principal balance and the interest attached to the loan.

Amortization is used in loan repayments, most commonly in mortgage loans or sinking funds. The payments are divided into equal amounts for the duration of the maturity schedule. Because of this uniformity, the amortization is regarded as the simplest repayment model.

Payment towards the amortization is mostly applied to the interest of the loan at the beginning of the amortization schedule, while an increased percentage of payment is used to satisfy the principal at the end of the amortization loan.

In an accounting sense, loan amortization refers to expensing the cost of acquisition from the residual value of intangible assets such as patents, trademarks, copyrights or other forms of intellectual property.In a more common sense, amortization refers to the tangible process of paying off a debt, such as a loan or a mortgage. The process in a loan amortization is satisfied through the delivery of regular payments made at uniform times. A portion of each payment is used to satisfy the interest while the remaining payment amount is applied towards the principal balance. The percentage that goes into satisfying both the interest and the principal balance is determined through the amortization schedule.

Loan amortization schedules are deciphered by the macro-economic conditions of the market, (primarily the interest rates) the credit score of the borrower and the intricacies that revolve around the specific loan.

How Do I Amortize a Loan?
A lender will amortize a loan to pay-off the outstanding balance through the delivery of equal payments on a regular schedule. These payments are structured so that the borrower satisfies both the principal and interest with the delivery of each equal payment.

Payments and amortization calculators are available on a number of lending websites; these tools facilitate the construction of an amortization schedule. If the lender wishes to understand the variable and inner-workings of the amortization calculation, please observe the below figures and steps:

• P= Principal amount (the initial amount of the loan)

• I= The annual interest rate (a figure from 1 to 100 percent)

• L= The length in years of the loan or the loan over which the loan is amortized

• J= The monthly interest

• N= The number of months over which a loan is amortized


To calculate the amortization, first take 1+J then take that figure to the minus N power. Take this number; subtract that figure from the number 1. Next, take the inverse of that and multiply the result by J then P. This figure represents the monthly payment (M). To calculate the amortization table you will need to do the following:

Step 1: Calculate H (P X J) to observe the current monthly interest rate.
Step 2: Calculate C= M-H to observe the monthly payment minus the monthly interest rates—this figure is the principal amount for that particular month.
Step 3: Calculate Q=P-C to observe the new principal balance for the loan.
Step 4: Set P equal to Q and observe Step 1 until the value of Q goes to zero.

NEXT: Understanding An Amortization Schedule