Amortization is the payment of an obligation in a series of installments or transfers. When paying off debts, part of the payment goes to interest and the rest goes to the principal. How much goes to each is determined by the amortization schedule. The calculation of amortization schedule is done by the lending party, whether a bank or the store where a purchase is made, with the formula depending on the type of amortization.
The different methods for determining amortization schedule include the following:
Straight line. This is method allocates an equal portion of the total amortization for a capital asset to each accounting period in its useful life.
Declining balance. This method, also called the accelerated amortization method, determines the amortization charges by applying a constant amortization rate (up to twice the straight-line rate) each year to the asset’s book value at the beginning of the year.
Annuity. This refers to a series of fixed payments to be paid regularly over a period of time. Examples of annuities include insurance payments and regular deposits to savings accounts.
Bullet. This method is unique in that the entire principal is paid of all at once at the end of the loan term.
Increasing balance. Also known as the negative amortization, this method allows for scheduled payments lower than the interest payments over that same time period. This means that borrowers get the benefit of lower monthly installments but as the same time makes it harder to get out of debt due to the increasing principal.