What Is Amortization In Relation To Finance

Article Written By: RebbecaMyers

If you are new to the world of finance, one question you may want answered relates to what is amortization. In simple terms, amortization is the process of paying off a loan in the form of uniquely structured payments given on a periodic basis. An amortized loan is different than regular loans because of the way that the structure of the repayments are defined.

Perhaps the most common type of amortized loans that most people would come across are mortgages. In fact the terms "mortgage" and "amortization" come from the same Latin word "Mort". This root word can be transliterated as meaning to kill off, eliminate, or deaden, hence why it is used in relation to paying back a debt.

When planning to invest in real estate, it can be useful to check out what is APR and the information on a wide selection of mortgage broker's websites. It is likely that they will provide some information about amortized loans, and perhaps offer tools such as special online loan calculators that can be used to help understand the amortizing process in full.

Payments are typically calculated by a division of the principal with the number of agreed months that have been allocated for repayment. The interest is then added to the total. For each payment that is given, a percentage of the interest and the principal is eliminated.

It is important not to confuse an amortized with an interest only loan. They differ in so much that the latter would involve payments that are given going towards the interest that is due and not the principal, though there can be the option of choosing to make principal payments. For this reason, the money given each month is typically less with an interest only plan.

Because of the way they are structured, with an amortized loan it usually takes around half the life of the loan for the interest and principal payments to balance out. Over time the money being paid towards the principal begins to outweigh the interest, therefore depleting the balance at a faster pace.

Depending upon the lender chosen, there may be the option of paying an extra amount each month which is used specifically to bring down the principal balance. As the interest charged directly relates to the principal, by lowering this amount the interest will also come down. Making extra payments on a regular basis can reduce the term of a loan.

Hopefully you are now a lot clearer about the answer to the question what is amortization. It is important that you understand the language used by lenders if you are to choose a product that best suits your personal circumstances.

About the Author

Understanding what is amortization is an important step in in refinancing. You can find also what is APR and much more as relates to real estate.

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