What Is Amortization & How Does It Work?

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What Is Amortization?
In Real Estate
In Business
How Does Amortization Work?
Loans
Assets
Pros and Cons of Amortization
Set payments: A major advantage of an amortized loan is that, with a fixed-rate loan, you know exactly how much you'll be paying each month. Clear payment schedule: The payment schedule is pretty straightforward. For instance, your repayment schedule might be for five years, and you'll owe $500 each month.
You don't build equity at the beginning: Because most of your payment will be going toward interest when you start making payments and less toward the principal, you aren't building a lot of equity from the get-go. It's only over time that you'll gradually build more equity. Hard to see how much you're actually paying on a loan: With loan amortization, it might be hard to see exactly how much you're paying in interest fees over the course of the loan. You'll need to look at an amortization schedule to see how much of each payment is going toward the principal and how much is going toward the interest fees. Then, you can do some simple math to see how much you're paying in interest.
Can lower taxes: A major benefit of amortizing intangible assets is that it can lower your business’s tax burden, which translates to smart cash management for businesses. Can show higher income: Amortization can also show that your assets are worth more and that you have more income. This could come in handy if you are seeking more capital to grow your business, either from investors or in the business loan application process. It can also help you see more clearly what your business's earnings are.
Can be difficult to gauge the useful life of an intangible asset: It might be hard to figure out exactly how long an intangible asset might be useful for. For instance, computer software might end up being obsolete, or a license to a digital asset might not be as integral to a business's operations and success as initially anticipated. So while it may have been anticipated that the useful life of a license to a media property would be four years, it could end up being closer to one year. Can be difficult to figure out the costs of an intangible asset: Unlike a physical asset, such as a building or manufacturing equipment, it can be challenging to figure out the actual cost of an intangible asset.
What Can Be Amortized?
Loans
Assets
What Can't Be Amortized?
Loans
Assets
Amortization Example
The Takeaway
Frequently Asked Questions
About the Author
Jackie Lam is a freelance writer with experience covering small business, budgeting, freelancing and money, and personal finance. She has written for more than 60 outlets, including Salon.com, CNET, BuzzFeed, Business Insider, and Time's NextAdvisor. She is currently working on her AFC® financial coaching certification to help artists, freelancers, and small businesses.
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