What is Amortization and How is it Calculated?
An amortization calculator is used to determine the periodic payment amount due on a loan (typically a mortgage), based on the amortization process.
The amortization repayment model factors varying amounts of both interest and principal into every installment, though the total amount of each payment is the same.
Amortization (or amortization; see spelling differences) is paying off an amount owed over time by making planned, incremental payments of principal and interest. To amortize a loan means "to kill it off". In accounting, amortization refers to charging or writing off an intangible asset's cost as an operational expense over its estimated useful life to reduce a company's taxable income.
An amortization schedule calculator is often used to adjust the loan amount until the monthly payments will fit comfortably into budget, and can vary the interest rate to see the difference a better rate might make in the kind of home or car one can afford. An amortization calculator can also reveal the exact dollar amount that goes towards interest and the exact dollar amount that goes towards principal out of each individual payment. The amortization schedule is a table delineating these figures across the duration of the loan in chronological order.
Applications of Amortization
- When used in the context of a home purchase, amortisation is the process by which loan principal decreases over the life of a loan, typically an amortizing loan. As each mortgage payment is made, part of the payment is applied as interest on the loan, and the remainder of the payment is applied towards reducing the principal. An amortisation schedule, a table detailing each periodic payment on a loan, shows the amounts of principal and interest and demonstrates how a loan's principal amount decreases over time. An amortisation schedule can be generated by an amortisation calculator. Negative amortisation is an amortisation schedule where the loan amount actually increases through not paying the full interest.
- In tax law in the United States, amortization refers to the cost recovery system for intangible property.
- In business, amortization allocates a lump sum amount to different time periods, particularly for loans and other forms of finance, including related interest or other finance charges. Amortisation is also applied to capital expenditures of certain assets under accounting rules, particularly intangible assets, in a manner analogous to depreciation.
- In computer science, amortised analysis is a method of analyzing the execution cost of algorithms over a sequence of operations.
- In the context of zoning regulations, amortisation refers to the time period a non-conforming property has to conform to a new zoning classification before the non-conforming use becomes prohibited. For example, if the city rezones property from industrial to residential and sets an amortisation period of one year, all property within the rezoned boundary must move from industrial use to residential use within one year.
- In the context of Securitization the Joshua Curve relates to a unique amortisation profile that results in the innovative "horseshoe Shape" or "J Shape" weighted average life ("WAL") distribution. In other words, if the base case results in a WAL of 10.0 years, the stress case and performance case would both result in reduced WALs that are both less than 10.0 years due to accelerated amortisation.
- one year, all property within the rezoned boundary must move from industrial use to residential use within one year.
- In the context of Securitization the Joshua Curve relates to a unique amortisation profile that results in the innovative "horseshoe Shape" or "J Shape" weighted average life ("WAL") distribution. In other words, if the base case results in a WAL of 10.0 years, the stress case and performance case would both result in reduced WALs that are both less than 10.0 years due to accelerated amortization.
Amortization of loans
In lending, amortization is the distribution of loan repayments into multiple cash flow installments, as determined by an amortization schedule. Unlike other repayment models, each repayment installment consists of both principal and interest. Amortization is chiefly used in loan repayments (a common example being a mortgage loan) and in sinking funds. Payments are divided into equal amounts for the duration of the loan, making it the simplest repayment model. A greater amount of the payment is applied to interest at the beginning of the amortization schedule, while more money is applied to principal at the end. Commonly it is known as EMI or Equated Monthly Installment.
Amortization of intangible assets
In accounting, amortization refers to expensing the acquisition cost minus the residual value of intangible assets in a systematic manner over their estimated "useful economic lives" so as to reflect their consumption, expiry, and obsolescence, or other decline in value as a result of use or the passage of time.
While theoretically amortization is used to account for the decreasing value of an intangible asset over its useful life, in practice many companies will amortize what would otherwise be one-time expenses through listing them as a capital expense on the cash flow statement and paying off the cost through amortization, having the effect of improving the company's net income in the fiscal year or quarter of the expense.
Depreciation is a corresponding concept for tangible assets. Methodologies for allocating amortization to each accounting period are generally the same as these for depreciation. However, many intangible assets such as goodwill or certain brands may be deemed to have an indefinite useful life and are therefore not subject to amortization (although goodwill is subjected to an impairment test every year).
Amortization is recorded in the financial statements of an entity as a reduction in the carrying value of the intangible asset in the balance sheet and as an expense in the income statement.