What is an Amortized Loan and How Does it Work?

An amortized loan is a type of finance that is repaid over a defined period. The borrower pays the same EMI every month for the duration of the loan. The first part of the payment goes towards interest and the remaining amount goes towards the outstanding loan principal. Towards the end of the loan tenure, a larger portion of each payment goes towards the outstanding principal and a smaller portion towards interest.

Loan amortization determines the minimum monthly instalment, although an amortized loan does not prevent the borrower from making additional payments. Any amount paid apart from the regular EMIs as part pre-payment is usually applied to the outstanding principal. This enables the borrower to save some money on the overall interest payout over the loan period .

The process of scheduling a fixed-rate loan into an equated monthly installment plan is known as loan amortization. The interest component of each instalment is deducted, and the remainder is applied to the loan balance. A loan amortization calculator or table template is the simplest method of calculating payments on an amortised loan. You can use our home loan EMI calculator or LAP EMI Calculator to view the loan amortization schedule within seconds - all you have to do is enter the loan amount, interest rate and tenure and then click on the “Schedule EMI Payments” button. 

To calculate monthly payments and summarise loan repayment terms for borrowers, lenders use amortisation tables. Borrowers can use amortisation tables to estimate their loan schedule, and plan their finances including tax payments.

How does it work?

Loan amortization divides a loan’s total into equal payments throughout the life of the loan, taking into consideration the loan amount, duration, and interest rate. Borrowers may see how much interest and principal will be charged as part of each monthly installment, as well as the total balance after each payment on this loan amortization schedule. Borrowers can also benefit from a loan amortization table where they can backward engineer a repayment to see how much amount they have available and calculate the total interest paid for tax purposes each year (this applies to mortgages, student loans and other loans with tax-deductible interest)

How to Amortize loans?

Using an online loan calculator or a template spreadsheet like those found in Microsoft Excel is the simplest way to amortize a loan. The borrower can use the equation given below to manually amortise a loan if they wish. The requirements for the calculation are: The total loan amount, the loan amortisation period (how soon they have to repay the money), the payment frequency (monthly or quarterly), and the interest rate.

Follow this calculation to compute the monthly payment on an amortised loan:

(a / {[(1 + r) n]-1}) divided by ([r (1+r) n])

• a=total Loan Amount (annual rate / number of instalments each year)
• r=per month interest rate (number of instalments each year x length of loan in years)
• n= total number of instalments

Then multiply the entire amount by the interest rate to see how much payment would go toward interest. Divide the result by 12 to get the amount paid in interest monthly. Subtract the interest amount from your total monthly payment to determine how much of every payment will go toward the principle.

Subtract the amount of principal paid in that period from the previous month's outstanding balance to compute the outstanding balance each month. Use the same calculations in consecutive months, but instead of starting with the original loan amount, start with the remaining principal balance from the previous month.

For example, consider a INR 200,000 loan extended at a 6% interest rate and amortized over two years. After calculation, monthly payment comes upto INR 8,864.12 where for the tenure of 24 months, overall Loan repayment is INR 212,738.93 out of which the Total Interest payout is INR12,738.93

Must Read : How Home loan Amortisation Schedule Calculated

Amortization Table

The scheduled payments on a loan are listed in an amortisation table, which is calculated using a loan amortisation calculator. Based on the total loan amount, interest rate, and loan term, the table estimates how much of each monthly installment goes to principal and interest.

Conclusion:

Amortized loans are the most common form of loans these days, especially those that have to be repaid via EMIs. Use the home loan EMI Calculator from SMFG Grihashakti free of cost to view your loan amortization schedule and take one step closer towards efficient financial planning.