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Simple English definitions for legal terms
loan-amortization schedule
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A quick definition of loan-amortization schedule:
A loan-amortization schedule is a plan that shows how each payment made towards a loan is divided into two parts: interest and principal. At the beginning of the loan, the interest part is usually the largest, but it decreases over time. The purpose of the schedule is to help borrowers understand how much of their payment goes towards paying off the loan and how much goes towards interest. Negative amortization is when the monthly payments are not enough to cover the accruing interest, causing the loan's principal balance to increase. Amortization can also refer to the process of spreading out the cost of an intangible asset, like a patent, over its useful life.
A more thorough explanation:
A loan-amortization schedule is a plan that divides each loan payment into two parts: the interest component and the principal component. The interest component is the amount of money that goes towards paying the interest on the loan, while the principal component is the amount of money that goes towards paying off the loan itself.
Typically, the interest component is the largest part of each payment at the beginning of the loan and gradually decreases over time. This means that more of each payment goes towards paying off the loan as time goes on.
For example, let's say you take out a $10,000 loan with a 5% interest rate and a 5-year term. Your loan-amortization schedule might look something like this:
| Payment | Interest | Principal | Balance |
|---|---|---|---|
| 1 | $41.67 | $166.67 | $9,833.33 |
| 2 | $40.97 | $167.37 | $9,665.96 |
| 3 | $40.26 | $168.08 | $9,497.88 |
| 4 | $39.54 | $168.80 | $9,329.08 |
| 5 | $38.81 | $169.53 | $9,159.55 |
In this example, each payment is divided into an interest component and a principal component. At the beginning of the loan, the interest component is larger than the principal component, but over time, the principal component becomes larger as more of the loan is paid off.
Loan-amortization schedules are important because they help borrowers understand how much of each payment is going towards interest and how much is going towards paying off the loan. This can help borrowers make informed decisions about their finances and plan for the future.