Amortisation
Also written Loan amortisation · Amortisation schedule · Amortization
The repayment of borrowed capital over a fixed term through equal instalments, each of which is split between interest and principal in proportions that shift over the life of the loan.
In plain language
A borrower takes Rs 30 lakh and pays back the same amount every month for fifteen years. Nothing about that instalment changes. What changes, invisibly, is what it is buying.
In the early months almost the whole instalment is interest — the loan is large, so the interest charged on it is large. As principal is chipped away, the interest charged each month falls, and because the instalment is fixed, the amount left over to repay principal grows. By the closing years the same rupee is nearly all principal.
The amortisation chart is simply that split, month by month, printed out. It is the document a borrower needs for tax, for prepayment decisions, and for understanding why five years of paying has barely dented the outstanding balance.
How it works
The instalment is the EMI, and it is set so that the present value of all the instalments equals the amount borrowed. Once fixed, the arithmetic each month is mechanical:
- Interest for the month = outstanding balance x monthly rate.
- Principal repaid = EMI - interest.
- New outstanding = old outstanding - principal repaid.
The monthly rate is the annual rate divided by 12. On a 7.5% loan that is 0.625% a month.
The consequence the workbook draws out is the one borrowers find counter-intuitive: the interest component is higher in the earlier period of the loan and becomes smaller as the capital component increases with time. The EMI gives stability and certainty; it does not give even progress.
The formula
Interest in month n = Outstanding balance at start of month n x (annual rate / 12)
Principal in month n = EMI - Interest in month n
In Excel: IPMT(rate, period, nper, -principal) -> interest component
PPMT(rate, period, nper, -principal) -> principal component
type = 0, i.e. instalment paid at the end of the period
A worked example
The workbook's own case. J is servicing a 15-year home loan of Rs 30,00,000 at 7.5%, paying an EMI of Rs 27,810. He wants the split for tax planning.
Month 1:
Interest = 30,00,000 x 0.625% = Rs 18,750
Principal = 27,810 - 18,750 = Rs 9,060
Two-thirds of the first instalment is interest. After a full year of paying Rs 3,33,720, the outstanding has fallen by barely Rs 1.13 lakh.
Month 61 — the start of the sixth year, the figure the workbook asks for:
| Component | Rs |
|---|---|
| Principal | 13,167.39 |
| Interest | 14,642.98 |
| EMI | 27,810 |
Five years in, interest is still the larger half — just. The crossover, where principal first exceeds interest, arrives only shortly after this point.
Work backwards from the interest figure and you recover the outstanding balance:
14,642.98 / 0.625% = Rs 23,42,877 still owed
So after paying Rs 16,68,600 over five years, J has retired Rs 6,57,123 of principal. The remaining Rs 10,11,477 went to the bank as interest. That single comparison is the strongest argument an adviser has for prepaying early rather than late.
Why NISM asks about it
Chapter 4 (Debt Management and Loans), section 4.7.6, sitting between hire purchase and refinancing, and drawing on the EMI computation in Chapter 2 (Time Value of Money). The paper asks for the principal and interest components of a specified instalment number — the workbook's own sample question asks for the 61st period and expects IPMT and PPMT with type = 0 — and asks conceptually which component dominates early in the tenor.
Common exam traps
- The EMI is constant; its composition is not. A question asking "what happens to the interest component over the tenor" is testing exactly this.
- Divide the annual rate by 12 and multiply the years by 12. 7.5% for 15 years is 0.625% for 180 periods — the single most common arithmetic slip in this chapter.
- Type = 0. The instalment is paid at the end of the period. Setting type = 1 turns it into an annuity due and every number changes.
- Prepayment reduces the outstanding principal and shortens the remaining EMI period — it does not reduce the EMI itself unless the borrower asks for that instead. RBI has mandated no prepayment charges on home loans taken from banks; car loans and others may still levy them, or bar prepayment for an initial period such as 12 months.
- Pre-EMI interest is not amortisation. Where a loan is disbursed in stages, as for an under-construction property, the borrower pays interest only; no capital is being repaid, so no amortisation is happening yet.
- Extending the tenor lowers the monthly outgo but raises total interest paid. The workbook says this in terms: the loan is repaid over a longer period and the total interest over the tenor goes up.