Amortization is a term you’ll hear when you apply for a home loan or a car loan, though many people aren’t entirely sure what it means—even people who have a home or car loan.
The good news is that amortization is a straightforward, simple concept, perhaps so much so that the reason you may not know its definition is only because you really do—you just don’t realize that’s what it’s called.
Amortization is, simply told, the slow and systematic payoff of a loan by a certain date. Loans which are amortized are called “amortized loans.”
Amortization comes from a Latin word which means “to deaden.” Perhaps a better translation in our day would be “to extinguish.” Amortization refers to the gradual extinguishment of a debt.
What amortization doesn’t imply is a consistent rate of payoff. Amortized loans include interest as well, and the majority of amortized loans are paid off in a fashion which includes the interest before the principal.
When you take out a loan on a home, most of your initial payments will go toward the interest on the loan, not the principal, but after a period of time has passed larger percentages of your payments will go toward the principal. During the final years of your mortgage, the entire amount of your payments will go toward the principal on the loan.
An “amortization table” or “amortization schedule” can show you exactly how this works for your own loan. You’ll be able to see exactly how long it’ll take to pay off yours by looking at one, and how long it’ll take you to actually own significant equity in your home.
Not all loans share the exact same terms, so if you are applying for an amortized loan, be sure to ask your lender the specifics which apply to you. Only once you completely understand the terms of your loan should you commit to the amortization process.
It is the gradual elimination of debt, such as a mortgage loan, by making scheduled payments of principle and interest which are sufficient to pay off the mortgage loan by the maturity date.
Example - a 30 year fixed loan would "mature" and be paid off 30 years after your first scheduled payment.
You could also say, it details exactly what percentage of your payment goes towards principle and interest each month over the life of the loan.
Most amortized mortgage loans take more than half of the life of the mortgage loan or longer for the principle and interest payments to become equal.
Some people choose to pay additional amounts towards principle each month, with every extra dollar helping to reduce the cost and length of the mortgage loan considerably.
Remember to clearly instruct your lender to apply the additional sum directly towards principle or they may apply it towards interest.