Definitions (2)

1. The gradual elimination of a liability, such as a mortgage, in regular payments over a specified period of time. Such payments must be sufficient to cover both principal and interest.

2. Writing off an intangible asset investment over the projected life of the assets.

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Applications of amortization

In business, amortization refers to spreading payments over multiple periods. The term is used for two separate processes: amortization of loans and amortization of intangible assets.

Amortization of loans

In lending, amortization is the distribution of payment into multiple cash flow installments, as determined by an amortization schedule. Unlike other repayment models, each repayment installment consists of both principal and interest. Amortization is chiefly used in loan repayments (a common example being a mortgage loan) and in sinking funds. Payments are divided into equal amounts for the duration of the loan, making it the simplest repayment model. A greater amount of the payment is applied to interest at the beginning of the amortization schedule, while more money is applied to principal at the end. Commonly it is known as EMI or Equated Monthly Installment.[1]

or, equivalently, where: P is the principal amount borrowed, A is the periodic payment, r is the periodic interest rate divided by 100 (annual interest rate also divided by 12 in case of monthly installments), and n is the total number of payments (for a 30-year loan with monthly payments n = 30 × 12 = 360).

Negative amortization (also called deferred interest) occurs if the payments made do not cover the interest due. The remaining interest owed is added to the outstanding loan balance, making it larger than the original loan amount.

If the repayment model for a loan is "fully amortized," then the very last payment (which, if the schedule was calculated correctly, should be