Loan Amortization

  • By Admin
  • September 30, 2013
  • Comments Off on Loan Amortization

IMG_20130930_142449Amortization is a fancy way of describing the process of paying off a loan in equal installments over a period of time.  When a loan is calculated to be paid off in a certain period of time, say 30 year, it is said to be “amortized” over 30 years.

It is important to note that the installment payments are of the same amount.  A portion of each payment goes toward paying off the interest incurred for the period and the remainder is to pay down the principal, or the loan balance.  As the balance of the loan is gradually reduced, a progressively larger portion of each payment goes toward reducing principal.

Loans are amortized over different periods of time.  The longer the amortization period, the lower the monthly payments are.  However, this incurs more interest over time.

When taking out a mortgage, an amortization schedule can be obtained from the loan agent.  An amortization schedule tells exactly how much is loan balance owed, how much interests has been paid, and the portion of the payment going towards paying the interest and the part paying down the balance, at any given time during the loan term.

Some loans can be “negatively amortized”.  A loan is said to have “negative amortization” feature when the loan balance results in a larger amount than the original loan borrowed.  This is due to the payments being smaller than the interest accrued during the same period.  The most common loans that allow the home owner to make smaller payments than their loan interests are Option ARM’s, Pick-a-Pay, 1% (or 2%) Loan, and variations and/or combination of them.  Loans with negatively amortized characteristics are often being advertised on the internet with unrealistically low payments and/or low interest rates, or with terminology such as “deferred interests” and “gradual payment mortgage”.  There are much negativity associated with “negative amortization” mortgages during the housing crisis in 2008.  This is mostly a result of unscrupulous loan agents selling temporary, low, teaser rates and payments as fixed rates and fixed payments to unsuspecting homeowners.  Negative amortization mortgages are not bad loans per se.  “Reverse mortgage”, one of the largest loan products with negative amortization feature offered in the United States, is a product of The Department of Housing and Urban Development, and HUD is overseen by Congress.  “Neg Am” loans can actually be good loan products for the right consumers.

In accounting, amortization is used as a method to write off the value of assets.   IRS rules allow the amortization of  intangible assets, such as goodwill.   As far as IRS rules are concerned, tangible assets, such as machinery, are depreciated.  Just like the purpose of depreciation in accounting, amortization of an intangible business asset is used for cost recovery purposes.

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