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What Does Amortization Mean?

What Does Amortization Mean?

Amortization is a method of computing equal periodic payments on an installment loan. When payments on a loan are initially made, they primarily go towards interest on the loan following an amortization schedule.

An example of an amortization repayment schedule on an amortized loan payment might be the following:

Steve takes out an installment loan of $500 to pay for car repairs he needs in order to continue working as a delivery driver for a pizza restaurant. The $500 loan, with an interest rate of 10% and a payment for $50 per month, might have $40 of the first payment go towards the interest rate and $10 of that $50 payment go towards the principal.

Somewhere in the middle of the amortization repayment schedule, Steve’s payments might be applied as such: $25 towards principal, and $25 towards interest (as long as Steve makes them in a timely manner to avoid any additional penalties and fees).

Closer to the end of the amortization schedule Steve is following to pay off his car repair loan, the payments might be the other way around ($40 going toward the principal and $10 going towards the interest) until the payment is completed in full on both the interest owed and the principal balance of the loan.

Loan providers may provide an amortization schedule to help borrowers determine the breakdown of where their payments are going and when they can expect to pay off the loan following that payment schedule and notwithstanding any extra payments they might make towards the loan.

Financial Terms and Definitions