Loans are an integral part of personal finance especially when you are planning to finance your education loan to study abroad. While applying for a loan it is very important to understand the terms and conditions and the repayment structure. Loan amortization is the process of paying off a loan over time through scheduled, periodic payments. It is one of the most important factors to understand when you are planning the repayment.
Most of the people often get confused about depreciation and amortization. However, both are different from each other and the outcome is also very different. Let’s understand in detail what is loan amortization and how it works as per the amortization schedule.
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How Does Loan Amortization Work?
Loan amortization works through a series of fixed, regular payments, often monthly, that are calculated to ensure that the loan is fully paid off by the end of its term. Usually, when you repay a regular loan then at the end of the tenure you pay some extra amount pending over some time. This may happen in case there is any penalty overdue or interest.
For example, you paid your EMI against an education loan for 12 months. In the last year, the total amount paid by you is INR 2,40,000.00, considering INR 20,000.00 as the EMI amount. Now, you want to check how much exactly you paid towards the principal and interest. Through the loan amortization schedule, you will understand the breakup and will be able to check the outstanding loan balance. If you have more funds you can also ask your lender to adjust EMIs and increase it. Usually, in the beginning, the major part of you The fixed and regular payments include two major components:
- Principal: The payment of the principal amount goes toward reducing the loan balance, effectively paying down the amount borrowed.
- Interest: The remaining part of the payment covers the interest that has accrued on the outstanding loan balance since the last payment.
Also Read: Education Loan Interest Rates
Confused? Here is what you need to understand. In the early stages of a loan, a significant part of each payment goes toward interest, while a smaller part reduces the principal. Over a period of time, as the principal balance decreases, a more substantial portion of each payment is applied to the principal, and the interest portion decreases. This means that when you started the loan repayment you paid the major portion of your EMI towards the interest and the remaining amount to the principal.
Benefits of Loan Amortization
There are a lot of benefits of loan amortization which you need to understand. It is always good to know the real value of assets, owed amount etc. Let’s understand the major benefits of loan amortization:
- Clarity of Terms and Conditions: In an amortized loan, the borrowers gain transparency into how their payments are applied, helping them plan their finances effectively. Through this, you will be able to understand how much amount is being paid towards interest and principal.
- Budgeting: Fixed monthly payments make it easier to budget and manage expenses, as borrowers know exactly how much they owe each month. This will help you to figure out your monthly expenses and you will keep that particular amount from your monthly income aside.
- Interest Reduction: Over time, as more of the payment goes toward the principal, borrowers pay less interest, ultimately saving money. This will reduce your overall burden of monthly payments and your credit score will ultimately increase.
- Loan Comparison: Amortization schedules allow borrowers to compare loan offers and choose the one that suits their financial goals best. You will be able to make a decision quickly about which scheme you are going with.
Also Read: Inflation and its Effects on Education Loan
Types of Loan Amortization
There are basically two types of loan amortization. One is fixed rate amortization and the other is variable rate amortization. The major difference between these two types of amortization is the interest rate charged against the loan amount. You can choose the category as per your loan requirement. Check out the difference below:
- Fixed-Rate Amortization: In this type of amortization, the interest rate remains constant throughout the loan tenure. This helps to make the monthly payments consistent.
- Variable-Rate Amortization: In variable-rate amortization the interest rates can change periodically in variable-rate loans, leading to fluctuating monthly payments. Borrowers should be prepared for potential rate adjustments.
Loan Amortization: Important Factors to be Considered
While you decide to choose the loan repayment structure there are some factors that are essential to be considered. As a borrower, you must understand how and why you should go with loan amortization in order to plan your loan properly and improve your financial management. Check some important factors below:
- Extra Payments: Making additional payments toward the principal can help pay off the loan faster and reduce interest costs. This will reduce the overall burden of the loan which you are facing every month. Always manage your income in such a way that you can make extra payments every month.
- Loan Term: Longer loan terms result in smaller monthly payments but potentially higher overall interest costs. Shorter terms lead to larger payments but lower total interest. Though banks can offer a maximum repayment of 15 years for an education loan you should always go for a shorter loan period so that you can finish off early and start planning for upcoming goals in life.
- Refinancing: If interest rates drop or your financial situation improves, refinancing your loan may be a smart move to reduce interest costs. This will let you reduce the overall cost of the loan.
FAQs
Amortization is basically the process of reducing the estimated value of a loan for an individual. Loan amortization is done on the basis of the loan amortization schedule, which is also a structured payment similar to the Equated Monthly Installments or EMI.
There are basically two types of amortizations- (a) Fixed rate amortization and (b) Variable rate amortization.
If you are looking for a long-term loan and want to make extra payments without penalty then you must choose loan amortization.
Loan amortization is a good option for individuals planning to take a long-term loan. It will help you to manage your finances in a better way and there will be complete transparency in the repayment system. You will get to know the exact breakup of payment towards principal and interest.
To know more about loan amortization, interest rates, the best international bank accounts for students, forex and banking experience for global students or international money transfers, reach out to our experts at 1800572126 to help ease your study abroad experience. Follow our social media handles on Twitter, LinkedIn and Instagram.
