When you take a loan, whether it’s for a home, car, or any other purpose, the word “amortization” comes multiple times. But what does loan amortization really mean, and how does it impact your EMIs and loan repayment strategy? Let’s understand in detail.
Think of eating a mango – you can't eat it all at once, so you enjoy it slice by slice. Loan amortization works the same way. Instead of paying back the whole loan at once, you repay it in smaller, regular payments over time.
In simple words, amortization is a repayment method where each EMI you pay covers two parts:
Principal Amount: The actual amount you borrowed.
Interest: The cost the lender charges for borrowing the money.
Over time, the portion of your EMI going towards the principal increases, while the interest portion decreases.
Key Point: In the beginning of your loan, most of your EMI payment goes towards interest. Over time, a bigger portion of your EMI starts paying off the actual loan amount (the principal).
Let’s get into the details. Suppose you borrow ₹50 lakhs to buy your dream home with an interest rate of 8% for 20 years. Your EMI might look like a constant figure every month, but behind the scenes, the composition of principal and interest keeps changing.
Here’s how it works in the first few years:
Year 1: You pay more interest because the loan amount is still large.
Year 10: The interest portion starts to decrease, and more of your EMI goes towards reducing the principal amount.
Year 20: By the end of the tenure, your payments mostly contribute to the principal, with little interest left.
Example Calculation: For a loan amount of ₹50 lakhs with a 20-year tenure at an 8% interest rate, your EMI would be around ₹41,822. In the first year, about ₹40,000 might go towards interest and only ₹1,822 to the principal. By the 10th year, more will contribute to the principal.
A loan amortization schedule is a table that shows how each EMI is split between interest and principal throughout the loan term. It helps you see how your loan will be paid off over time.
EMI Amount: The fixed monthly payment.
Interest Paid: The interest portion of each EMI.
Principal Paid: The principal portion of each EMI.
Outstanding Loan Balance: The remaining loan amount after each EMI.
Example Schedule for ₹10 lakhs Loan at 10% Interest (5-Year Tenure)
| Month | EMI (₹) | Disbursement Letter | Month | Month |
|---|---|---|---|---|
|
Month |
EMI (₹) |
Interest (₹) |
Principal (₹) |
Outstanding Balance (₹) |
|
1 |
21,247 |
8,333 |
12,914 |
9,87,086 |
|
2 |
21,247 |
8,226 |
13,021 |
9,74,065 |
|
3 |
21,247 |
8,117 |
13,130 |
9,60,935 |
|
… |
… |
… |
… |
… |
|
60 |
21,247 |
177 |
21,070 |
0 |
An amortization schedule provides a clear view of how your loan is reducing over time.
Understanding loan amortization has several benefits:
Knowing how much interest you pay in the early years helps you plan extra payments and manage your finances more effectively.
Consider making prepayments when possible to reduce the interest burden and shorten your loan tenure.
Home loan borrowers can claim tax benefits under Section 80C and Section 24(b) of the Income Tax Act. Understanding amortization helps in calculating your eligible deductions.
When comparing loans, an amortization schedule can help you decide which option has a lower overall cost.
Don’t just focus on the EMI. Look at the total interest paid over the tenure.
You can calculate loan amortization using formulas, but online calculators make it easier. Just enter the loan amount, interest rate, and tenure to get the schedule.
The formula to calculate EMI is:
EMI=P×r×(1+r) to the power n/ (1+r) to the power n −1
Where:
|
Aspect |
Details |
|
Definition |
Repayment in equal installments over time |
|
EMI Composition |
Principal + Interest |
|
Impact Over Time |
Interest portion decreases, principal increases |
|
Amortization Schedule |
Detailed breakdown of each EMI |
|
Importance |
Financial planning, tax benefits, loan comparison |
|
Prepayment Effect |
Reduces interest burden and/or loan tenure |
Loan amortization may seem complicated, but it's important for every borrower to understand. It affects how you repay your loan and helps with financial planning. Always check the amortization schedule before taking a loan and think about prepayment options to reduce interest costs. By understanding amortization, you can make better financial decisions.
How can EazyBankLoan help you in taking a loan?
We understand that getting a loan can be very stressful with confusing documents, unclear communication, and various other challenges. That is why we take care of your loan application process, saving you time and hassle by handling the paperwork and communicating with the loan providers.
Check the details at EazyBankLoan
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