Amortization is an accounting technique used to periodically lower the book value of a loan or an intangible asset over a set period. In simpler words, it is a way to pay back a loan. In relation to loans, it is focused on spreading out loan payments over time. Amortization can refer to two situations. The first being, used in the process of paying off debt through regular principal and interest payments over time. An amortization schedule is used to reduce the current balance on a loan through installment payments (this is often seen with mortgages and car loans). Its second use can also refer to the spreading out of capital expenses related to intangible assets over a specific duration for accounting and tax purposes. Amortization is similar to depreciation, as both of them involve the cost of holding an asset over time. Their main difference is that amortization refers to intangible assets (i.e., trademark, patents), whereas depreciation refers to tangible assets (i.e., equipment, buildings, vehicles). Amortization is important for helping businesses and investors understand and forecast their costs over time.
Used in a Sentence
After putting down five thousand dollars on the car, the buyer decided to amortize the rest through small payments over two years.
Amortization Calculation
Principal Payment = Total Monthly Payment – (Outstanding Loan Balance X Interest Rate/12 Months)
In words: Principal Payment is equal to Total Monthly Payment minus the Outstanding Loan Balance times Interest Rate over Twelve Months
