How Loan Amortization Works

What is loan amortization?

Loan amortization is a method of paying for both the principal of the loan and the interest in one fixed monthly payment.

The word “amortization” comes from the French root “mort” for “death” and “gage” for “pledge”. It means the “killing down” or “extinguishing” of debt over time.

One of the main benefits of loan amortization is the consistency that comes along with it.

How loan amortization works:

It allows you to pay off a debt over time with regular, equal payments.

At the beginning of the loan, your interest costs are at their highest. As time goes on, more and more of each payment goes towards your principal (and you pay less in interest each month).

The payment is based on the amount of the loan, the interest rate and how many years the loan lasts.

What are the benefits of loan amortization?

Loan amortization involves the breaking down of a conventional loan into easy monthly payment schedules.

You get fixed payments throughout the term of the loan. This may facilitate better budgeting, as borrowers know how much they will be expected to repay every month. Tracking payments is easier as a result.

The interest rate can be changed at certain predefined periods or it may be fixed for the life of the loan, depending on the agreement.

What are the cons of loan amortization?

The monthly payment doesn’t address how much money the borrower will pay on the initial debt over the term of the loan.

To reduce your interest cost, you need to make larger down payments.

Initial payments first go on the payment of interest and then the principal amount is cleared after the interest.

Monthly payments can be quite high, so borrowers need to be fully prepared before choosing this payment option.