Table of Contents
- What Are Netting Escrows & How Does It Work?: The Best Guide - January 2, 2024
- The Secret About Prescriptive Easement: Top Guide 1 Must Know - December 4, 2023
- About Home Equity Loans In Texas And How Can One Obtain It - November 27, 2023
What Is Amortization?
Amortization refers to the process of paying off a debt of principal and interest through regular monthly installments which are scheduled and predetermined is called amortization.
In almost every area the payments are made in the form of principal and interest if the applicable term is ‘amortization’.
The term amortization is related to debt or loan and also in the process of periodically lowering the value of intangible assets which is similar to the concept of depreciation.
What does Amortization mean?
The process of writing down the value of a loan or an intangible asset is amortization. Based on the specific maturity dates, lenders, such as financial institutions, use amortization schedules to present a loan repayment schedule.
Amortization of loans
When a debt is paid off completely in regular installments of interest and principal within a maturity date then that process of payment is referred to as amortization.
In the case of mortgage and auto loan payments, in the early stages of the loan, a higher percentage of the monthly payment goes toward interest.
Then with every payment, a greater percentage of the money goes toward the payment of the loan’s principal.
How to Calculate Amortization?
The most contemporary financial calculators, spreadsheet software packages, and online amortization charts are used to calculate amortization.
Their schedules start with the outstanding loan balance. When you multiply the interest rate with the outstanding loan balance and then dividing it by twelve you get the monthly payments.
The total monthly payment minus the interest payment for that month is the amount of principal due in a given month.
The next month’s outstanding balance is calculated as the previous month’s outstanding balance after deducting the most recent principal payment.
The interest payment is again calculated with the new outstanding balance, and the pattern continues till all the principal payments have been made and the loan balance is zero at the end of the loan term.
To calculate the monthly principal due the formula of amortized loan is
Total Monthly Payment –Outstanding Loan Balance * Interest Rate / 12 Months = Principal Payment
Amortization of Assets
When you are dealing with assets especially intangible assets amortization means differently.
Here amortization is the periodic reduction in value over a period of time that is similar to the depreciation of fixed assets and depletion, of natural resources.
When machinery or land or buildings (tangible assets) are purchased and used their value decreases after a certain period of time for example if a new forklift is bought for $30,000 it will not be worth the same amount after five or ten years later. Yet the assessment is accounted for in the company’s balance sheet.
When an asset’s initial cost is divided by its useful life or the time it is useful before replacing or repairing it is depreciation like the forklift’s is useful for ten years then its value will depreciate $3000 every year
In the case of intangible assets amortization refers to the act of depreciation.
Though it is more difficult to calculate the true cost and value of things because it is never fixed. Guidance is provided by accounting and tax rules on how to calculate the depreciation of the assets over time.
For tax planning the amortization of intangibles is useful. for certain expenses like geological and geophysical expenses, the taxpayers are allowed to take a deduction experienced in oil and natural gas exploration, atmospheric pollution control facilities, bond premiums, R&D, lease acquisition, forestation, and reforestation.
Also deductions in intangibles, such as goodwill, patents, copyrights, and trademarks by the Internal Revenue Service (IRS).
Conclusion
Amortization is referred to in two, situations it is used in the process of paying off debt through regular principal and interest payments overtime in the first situation.
An amortization schedule is used to reduce the current balance on a loan in the second situation, for example, a mortgage or car loan, through installment payments.
It can also refer to the spreading of capital expenses of intangible assets over a specific time duration for the purpose of accounting and tax.
Whether you are referring to the amortization of a loan or an intangible asset it is a periodic lowering of book value over a stipulated period of time.
The process of amortization is easy for a loan officer or accountant who has a clear understanding of the specific needs of the company or individual.
