What is Amortization?

Amortization Meaning

Amortization is the systematic repayment of a debt or other financial obligation, often paid in installments. In real estate, you may hear the term mortgage amortization. Mortgage amortization means making a down payment and then making monthly payments over several years.

An Example

Amortization is a common financial term that describes gradually paying down your mortgage debt. If you have a $250,000 30-year fixed-rate mortgage, for example, this means that each month your principal and interest payment would reduce the balance on your loan by approximately $1,286. In 30 years of steady mortgage payments, you will have paid off the entire loan and own the home free and clear.

Amortization Schedule

An amortization schedule, or a payment schedule, calculates the amount of interest and principal borrowers pay in each installment of an annuity, mortgage loan, or installment loan. Property investors can use this table to determine how much they’ll owe at any given time.

Accumulated Amortization

We call the total amount of an asset’s loss over its useful life ‘amortization’. In other words, this is the amount paid off of the asset’s initial cost. For example, if you take out a mortgage for $200,000 and pay down $100,000 of principal at a 5% interest rate (by making monthly payments), then your accumulated amortization would be $100,000.

How to Create a Schedule

An amortization schedule lists each payment made on debt over the life of the loan. All payments are listed in descending order, with each payment’s total amount decreasing as the loan balance decreases. To do the calculation, you’ll need to know your original loan amount, the number of monthly payments, and the interest rate.

Once you have these figures, you can calculate your total interest for each repayment period and your new loan balance after each repayment period.

Calculators 

The quickest way to calculate amortization and ROI on a specific property is to visit our rental property calculator. Enter the desired property’s purchase price, down payment percentage, number of payments, and interest rate, and you’ll be given your monthly payment and final loan balance.

EBITDA

Another common financial term is EBITDA, which stands for earnings before interest, taxes, depreciation, and amortization. EBITDA measures a company’s profitability by subtracting all expenses from the company’s total revenues. EBITDA is harder for business owners to influence than earnings per share or net income because it doesn’t include costs that a company wouldn’t have to pay if it didn’t have to borrow money or own property.

Negative Amortization

Amortization involves borrowers paying down their loan balance. Negative amortization occurs when borrowers make less than the required monthly payment and their principal balance increases over time. This can happen when you make a small down payment or take out a large mortgage without determining what it will cost in monthly payments.

Comparing Depreciation with Loan Repayment Spreading

It’s important to recognize that amortization and depreciation differ. Amortization has two primary uses: one for reducing a balance and one for reducing interest expenses. Depreciation, on the other hand, is always used to reduce an asset’s value over time.

The difference between these two terms is best illustrated by looking at them side-by-side. With both forms of cost reduction, a process reduces or decreases the value over time. With amortization, this happens over the life of a loan or lease agreement; with depreciation, it happens all at once when something first starts being used up, such as when a new car is driven off the dealership’s lot for the first time.

In summary, amortization and depreciation are very different concepts but can be related through finance. In accounting terms, amortization represents periodic reductions to account for the decrease in the value of an intangible asset (a loan or mortgage). Depreciation also represents periodic reductions (of capital expenditures) to account for the decreased value of tangible assets.

One significant distinction between the two is their timing: Amortization occurs gradually throughout a mortgage or loan’s life, while depreciation occurs immediately after a company acquires a new property.

Another key difference is that amortization affects the debtor’s cash flow more than depreciation. Unlike the spreading out of loan payments over time, which impacts an individual’s monthly financial obligations, depreciation influences a company’s annual tax liabilities.