What is Loan Amortization?

According to dictionary.com the word “amortize” means:

“to liquidate or extinguish (a mortgage, debt, or other obligation), especially by periodic payments to the creditor or to a sinking fund.”

What does that mean?

Lenders like to lend money on a fixed payment, that don’t change over the course of the loan. But by doing that, the amount of principle, or balance of the loan, goes down over the course of the loan. Thus they can’t charge the same amount of interest on the balance.

Therefore the payment, which is a fixed amount, is broken into two parts, principle [amount of money applied to paying down the loan] and interest [amount of money the bank charges you for borrowing from them].

With an amortized loan, at the beginning, the payment is more interest, and the principle is less. Toward the end of the loan, the principle is more, the interest is less.

Most mortgages, and auto loans are typically amortized loans. When you take out a loan you should be given a payment schedule showing you the amounts of principle and interest for each payment.

The alternative would be an interest only loan. Where the periodic payment would be interest only, and the principle would not decrease. This is sometimes called a “balloon note.” At the end of the loan term the borrower would have to pay off the entire principle that would have not decreased during the life of the loan. A couple of examples of these types of loans might be a home equity line of credit (HELOC) or a credit card.

We offer calculators to allow you to see exactly what a potential loan or mortgage would look like based upon loan amount, interest rate, and term or years borrowed.

Click here to plug in the numbers to see.