Amortized Loans



Amortized Loans

Introduction

Amortization is a term used in economics and accounting and is based on the distribution process at the time of lasting value. It is also used as a synonym for depreciation on any of its methods.

In terms of financial aspect, the term amortization refers to the process of gradual repayment of a debt. The obligation to repay a loan from a bank is a liability whose amount is reintegrating into several payments deferred in time. The share of borrowed capital (or main) is canceled in each of these payments, that is called an amortization.

Discussion

Most of the businesses tend to go for loans which may be amortized or non-amortized. In case of amortized loans repayment, the amount is calculated using the method of constant financial system, also known as the French system. It means that the total fee payable (amortized capital + interest) will always be the same during the life of the loan (unless the review is rising or falling interest rates on variable rate mortgages), but the percentage of capital written off and interests vary.

Interest is calculated at the rate of interest on capital to be repaid at any time. Therefore, in the first installments you will be paying interest on total debt. These interests comprise the majority of the total fee and will only be amortized (paying the debt) a small amount of capital outstanding.

Whenever the professionals in the field of finance and accounting use the term 'amortized loans', they actually refer to an advanced procedure of splitting up a traditional loan into convenient payment schedules spread over several months. In amortized loans, the whole amount of principle and interest are merged to form stable monthly payments that do not fluctuate due to the fixed interest rate. Usually, the amortized loans are found in the cases of huge loans. The best example of an amortized loan is a mortgage and it can be observed that majority of the mortgage companies prefer amortizing their loans.

There are a few advantages and disadvantages associated with the amortized loans. That is why some borrowers are in favor of amortized loans, whereas others are not. Several benefits are related to the easy repayment modes of amortized loans. On the other hand, many of its disadvantages are related to particular issues associated with clarity in lending.

Advantages

One of the major advantages linked with amortized loans is that they provide the borrower, a clear and easy installment payment on monthly basis. These loans are also usually simpler to trace as the monthly installment amount is pre-defined. Whereas, variable amount of payments might create a lot of trouble. Similarly, in mortgage lending, the addition of amortized standard helps in making the process simpler and straightforward.

Disadvantages

According to some borrowers and analysts, the contemporary system of practicing the amortized loan system in many countries is not perfect. A non-amortized loan may prove to be simpler to understand for some amateur borrowers. Another issue is related to equity building. Equity is the amount of capital that is raised ...