Amortization is the process of paying a loan over a period of time. It mainly refers to paying off debts in installments through a fixed repayment schedule. Initially, the portion of the interest payment is high and the principal amount payment is low. Whereas, at the end of loan tenure, the portion of interest payment is low and principal payments are high.
The term “amortization” is used for two different process-amortization of loans and amortization of assets.
Amortization of loans
Upon loan disbursal by lender, the loan repayments are divided into multiple cash installments as determined by an amortization schedule. Every repayment installment consists of both principal and interest. Payment is divided into a certain number of equal amount installments for the applied tenure of the loan. Commonly known as EMI or Equated Monthly Installment.
Amortization of assets
It represents to allocating the cost of an intangible asset over a period.Amortization is recorded in the financial statement of a company as a reduction in carrying value of the intangible asset in the balance sheet as an expense in the income statement.
Suppose you have taken a home loan of INR 60,00000 for 20 years tenure at an interest rate of 7.35%. Equated monthly installment of INR 47,787 buyer will repay to the bank, it includes both principal and interest components in it. If it were not amortized, each month the payment would change accordingly. Through amortization, schedule repayment is made into an equal regular monthly process.