Amortization

Quick definition

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Updated: Feb 9, 2023

Amortization is the process of paying off a loan or debt in regular instalments over a set period of time, including both the repayment of the principal amount borrowed and the payment of interest.

3 key takeaways

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  • Amortization schedules outline payment breakdowns.
  • Payments are split between paying off the principal and paying interest.
  • Loan term affects total cost and monthly payment amount.

What is amortization?

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Amortization is a method used to repay a loan or debt over a set period of time by making regular payments that include both the repayment of the principal amount borrowed and the payment of interest on the loan. The goal of amortization is to fully repay the loan by the end of the loan term.

Amortization schedules

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One important tool in the process of amortization is the amortization schedule, a table that outlines the exact amount and allocation of each payment. The schedule shows how the loan balance decreases over time, helping individuals and businesses understand the exact cost of their loans.

Interest and principal

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Interest is the cost of borrowing money and is expressed as a percentage of the loan amount. The interest portion of each payment decreases as the loan balance decreases. The principal is the amount of money being borrowed and is the portion of each payment that goes towards paying off the loan balance.

Loan term

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The loan term is the length of time over which the loan is scheduled to be repaid. A shorter loan term means higher monthly payments but lower overall interest costs, while a longer loan term means lower monthly payments but higher overall interest costs. The loan term should be carefully considered as it affects the total cost of the loan and the monthly payment amount.

In conclusion, amortization is a useful tool for managing debt and helps individuals and businesses understand the exact cost of their loans over time. By following an amortization schedule and making regular payments, loans can be paid off in a timely manner and individuals and businesses can make informed decisions about financing and budgeting.



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James Knight
Editor of Education
James is the Editor of Education for Invezz, where he covers topics from across the financial world, from the stock market, to cryptocurrency, to macroeconomic markets.... read more.