What is Loan Amortization: Understanding How Your EMI Payments Work 

Loan amortization is the method by which lenders divide your monthly EMI between payment of interest and repayment of the principal. Initially, your payments consist mainly of interest, but later a greater amount of your payment goes directly towards reducing the actual loan balance.

Quick Reads

• Opting for a reducing-balance loan rather than a flat-rate loan allows you to avoid paying too much interest.

• In the beginning, it is best to pay a little more towards the principal in order to cut down the total interest costs.

• At any time, you can obtain your repayment schedule from the app offered by your lender so that you can monitor your balance and get your tax proofs ready.

• If you can afford higher monthly installments, choose a shorter tenure to lower total interest.

When you take a loan, you think your monthly EMI is split equally between interest and the principal. That is a misconception. In fact, banks use a proper method for working out how much of your payment goes towards interest and how much is applied to reduce your loan balance. In this blog, let's understand the concept of amortization of loan so you have better control over your finances.

Loan amortization is the process that involves paying off a debt by making regular monthly payments over a set period. Each payment is split up into the amount that goes towards the principal and the interest charged. With an amortized loan, a large portion of your payment is applied to interest in the early stages. As you keep making payments, the amount that goes towards interest slowly decreases. The remaining part is used to pay down the principal until the whole loan has been paid off.

As we discussed above, loan amortization works by giving interest a first preference and then principal.

Suppose you take a loan of ₹10 lakh at an annual interest rate of 10% for a period of 5 years. Your monthly installment would then be approximately ₹21,247. During the time you are paying this amount, the bank begins its procedure. You will find it easier to understand with the help of the table given below:

Even if your EMI remains at ₹21,247, the interest amount decreases each month. As a result, a larger part of the payment is applied to the outstanding debt until it is fully paid off.

There are various loan amortization methods to calculate your monthly payments and reduce your debt over time.

• Straight-Line/Declining Balance Amortization: In this method, you make a fixed payment of capital each month together with interest on the remaining balance. The interest charge decreases each month, and the total EMI starts high and then falls over time.

• Flat Rate Amortization: With a flat-rate loan, interest is calculated on the original amount of the loan for the entire period of the loan. As a result, a '10% flat rate' is equivalent to about 18% to 20% when the balance is reduced.

• Bullet Repayment: With a bullet repayment, you pay off the full loan amount and all the interest in one lump sum at the end of the loan.

Generally, each method has an impact on the amount of EMI, the interest, and the principal you have to pay. Choosing the right amortization method can help you manage your loan more effectively.

It's a good idea to check your loan amortization schedule if you want to keep track of the amount of debt you still have, see how much interest you've paid, and plan your prepayments properly. Here are three simple ways to access it.

• Lender's Portal: You can download it directly from your lender's portal by logging into your bank's internet banking or mobile app. Then download your schedule right away. Alternatively, you can request an updated copy from customer support.

• Use an Online EMI Calculator: By entering your loan amount, interest rate, and tenure into the calculator, you can instantly see your EMI and a full month-by-month payment schedule.

• Construct Your Own Schedule in Excel or Google Sheets: By creating a custom table, you can use financial formulas such as =PMT to calculate the total EMI, =IPMT to determine the monthly interest, and PPMT to find the monthly principal repayments.

If you regularly check your schedule, you'll be in a position to fully control both your repayment progress and your tax proofs, as well as your pre-payment strategy.

Once you know how amortization of loan works, you'll get a better grasp of your EMI, the total amount of interest you'll pay, and the outstanding balance. This kind of knowledge can help you manage your loan with greater confidence. Moreover, if you ever need more money, choosing a lender that offers a simple, transparent, and convenient way to borrow will make the process easier. At Finnable, we offer an online personal loan of up to ₹10 lakh, with a paperless process and no collateral required. This gives you a convenient option to consider when planning your borrowing.