Amortization is the process of gradually paying off a loan through scheduled, periodic payments. Each payment typically covers both the interest charged by the lender and a portion of the loan’s principal balance.
How It Works
With amortization, the borrower makes consistent payments over a set period. At the start, a larger share of each payment goes toward interest. As the balance decreases, more of the payment goes toward the principal until the loan is fully repaid.
Applications
- Loans: Mortgages, car loans, and personal loans are typically amortized.
- Accounting: Amortization also refers to spreading out the cost of intangible assets (like patents) over their useful life.
Benefits
Amortization makes large debts more manageable by dividing repayment into smaller, regular installments. It also provides clarity on how much is paid toward interest versus principal over time.
Final Thoughts
Understanding amortization is key to managing debt effectively. It helps borrowers see the long-term cost of loans, plan repayments, and explore strategies—such as making extra payments—to reduce interest costs and pay off debt faster.