What is Amortization?

Amortization is process of paying off a debt (often from a loan or mortgage) over time through regular payments. A portion of each payment is for interest while the remaining amount is applied towards the principal balance. The percentage of interest versus principal in each payment is determined in an amortization schedule.

Amortization terminology is also fairly standard. The most commonly used words include principal, interest rate, and term.

The principal is the amount of money borrowed in the loan. If you get a loan for $250,000, the principal of the loan is $250,000. As you pay off the loan, the principal balance decreases. After 20 years, the principal balance (often just referred to as the balance) may be $135,000 for example.

The interest rate (or annual interest rate) is used to determine how much money is paid back to the lender in each payment period. In traditional loans, a calculation is performed with the remaining balance to determine how much of the payment goes toward interest.

The term is the length of a loan or mortgage usually measured in years or months. It is important to note that the term length does not always indicate the number of payments involved in the loan. A 15-year mortgage often will have 180 monthly payments (15 years x 12 months = 180).