Loan amortization

Definition

Loan amortization is the process of gradually paying off a loan through scheduled, pre-determined payments that include both principal and interest. The payment amounts are designed to fully repay the loan by the end of its term.

5 Must Know Facts For Your Next Test

1. The monthly payment amount remains constant throughout the life of an amortized loan.
2. Early payments in an amortization schedule are primarily applied to interest rather than principal.
3. An amortization schedule details each payment's allocation between principal repayment and interest.
4. Amortized loans typically include mortgages, auto loans, and personal loans.
5. Negative amortization occurs when the scheduled payments do not cover the interest due, causing the loan balance to increase.

Review Questions

• What does an amortization schedule show?
• How do early payments differ from later payments in a loan amortization schedule?
• What types of loans are commonly amortized?

Related terms

Principal:

The initial sum of money borrowed or still owed on a loan, excluding interest.

Interest:

The cost of borrowing money, usually expressed as a percentage of the principal.

Negative Amortization: A situation where scheduled loan payments are insufficient to cover the interest due, causing an increase in the outstanding principal balance.