Amortization is the process of gradually repaying a loan over a fixed period through scheduled payments that include both principal and interest.
How It Works:
- A loan is taken for a fixed tenure.
- A repayment schedule (amortization schedule) is created.
- Each payment includes:
- Interest (higher in early stages)
- Principal (increases over time)
- The loan balance reduces with each payment.
- The loan is fully repaid by the end of the term.
Benefits:
- Provides predictable repayment structure
- Helps in financial planning and budgeting
- Gradually reduces debt burden
- Commonly used for business loans and asset financing
Example:
A business takes a ₹15,00,000 loan for 5 years. It pays fixed monthly installments, where initially a larger portion goes toward interest, and over time, more goes toward reducing the principal.