What is meant by “amortization”?

Updated March 13, 2023.

Interest is charged on the amount that is borrowed (called “principal”). As payments are made to reduce the principal, the amount of interest owed each month is less, since it is being calculated on a lower amount of principal. However, in order to avoid confusion, the amount of each monthly payment does not change as the amount of interest due decreases. Instead, the monthly payment remains the same and a calculation, called an “amortization”, is made which allocates a smaller portion of each monthly payment toward interest (since the amount of interest due decreases as the principal of the loan decrease) and allocates a larger portion of each monthly payment toward principal. Therefore, at the beginning of the loan, the largest portion of the payment is going toward interest, whereas near the end of the loan, most of the payment represents a reduction in the principal.

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