Finance From A-Z: Amortization Period

Term: Amortization Period

Definition:
The period or length of time over which the principal portion of a loan is scheduled to be paid down through periodic payments.

What does this mean to you:

The amortization period you select has a significant impact on cash-flow so a conscious decision should be made on which period you select.

When you decide on an amortization period there is an inverse relation between cash-flow and capital savings. Meaning, a longer period has less annual cash outlay but, you spend more in interest because of the longer period of time – which means your company has less savings due to higher interest expense.

If you chose a shorter period the reverse is true. Annual cash-outflow is higher but you pay less is in expenses overtime which means more profit can be retained in the long run.

Example:
A $50,000; 15 year business loan at 8% has an annual payment of -$5,841.48. Over the life of the loan you will pay -$87,622. That’s -$37,622 in interest.

If you reduce your amortization period by five years to a 10 year Amortization Period, the annual pay-out is now -$7,451.47. Over the life of the loan you pay -$74,514.74. That’s a savings of $13,100 in interest with a trade-off of an annual increased cash outflow of -$1,609.90.

Ultimately, the decision on which Amortization Period you select is based on your company’s credit score, available cash-flow and your long-term financing strategy. So, don’t just take the first amortization period offered to you by your lender. You should analyze your options. Also, remember to negotiate a lower interest rate along with a shorter amortization period. The risk period is less for the lender so you should reap some of the benefits too.

Click on this link to see a quick loan calculator that will let you do some What-if scenarios to determine the interest and payment schedules

JR Dexter, Inc – “Business Decision Support”.
“Better Financial Decisions through Intuitive Analytics”