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What is Loan Amortization?
This is a common question that we are asked during the process of a loan application. Most loans of any type have “amortization”. If you have ever had a loan in the past it is very likely it was an amortized loan. While the word is a little ‘too formal’, the explanation of what it is and what it is does is relatively simple.
Firstly, let us explain that when you are repaying a loan to a licensed lender (I.e. a bank) you are repaying two sections of the loan. These two components are explained below:
Part 1: The principle of the loan. This is only the amount of money you have borrowed, no other charges are included here. For example, if you borrowed P40,000, the principle is just that P40,000 amount. Divided up over a 32 month repayment schedule, that P40,000 looks like this: P1,250 per month. (P1250 x 32 months = P40,000).
If you were repaying the lender just the P40,000, then the lender does not make any money from the agreement. They give you P40,000, and you give them back P40,000. Banks and lenders are a business, so they need to make some money from every agreement. That brings us to part two of your loan:
Part 2: The interest of the loan. The interest section of the loan is where the bank makes most of their profit from the loan. Using the earlier example again, the bank lends you P40,000 and says “ You must pay me back the P40,000 which I will give you in full now + you must pay me back 9% extra, each year”. Therefore, each month when you make a repayment to your lender you are repaying the principle amount of P1,250 + 9% interest. The exact interest rate a lender will charge will vary, we have used 9% here just for an example.
Your loan amortization is the calculation of how much you need to pay in total, and how long you need to repay it for until the amount owing to the bank is P0.00. This would also see the end of your loan and the agreement with your lender. Repaying the loan in full is very good for many reasons. The most important of course is that you are now debt free (assuming you have no other debts) and also that your have created a healthy credit rating with that lender. Therefore, if you wanted to avail a loan again from them and you had not harmed your credit rating with any other lender, credit card supplier, etc, then it is likely you would be approved again if you are still employed.
Any licensed lender will be able to provide you with a printed or electronic amortization schedule. This will illustrate to you how much you are going to repay each month including what date the amount is due. The loan you agree to will determine what is required by you as the customer, so be sure to read all the fine print in your loan agreement before making a decision on who to avail the loan from.