What is Amortization?
An Essential Property Management Term
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 a number of years.
An Example of Amortization
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.
An amortization schedule, or a payment schedule, is a table that calculates the amount of interest and principal paid 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.
The total amount of an asset’s loss over the course of its useful life is called its “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 an Amortization 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 calculate an amortization schedule, 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.
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.
Another common financial term is EBITDA, which stands for earnings before interest, taxes, depreciation, and amortization. EBITDA measures a company’s profitability. It is calculated by subtracting the total amount of 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.
Amortization refers to the process of paying down your loan balance. Negative amortization is when you make less than the required monthly payment and your 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.
Amortization vs. Depreciation
It’s important to note that amortization and depreciation are not the same. 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 amortization, which impacts an individual’s monthly payments on their loans, depreciation affects a company’s tax bills each year.
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