Amortization
The gradual repayment of a debt balance through regular installment payments over a specified time period.
Plain-English Explanation
Amortization is the process of spreading out a loan into a series of equal periodic payments. In the early years of an amortized loan (like a 30-year fixed mortgage), most of your monthly payment pays off interest. As time passes, a larger portion of each payment goes toward reducing the principal balance.
Where P is principal balance, r is monthly interest rate (annual rate / 12), and n is total number of monthly payments.
Real-World Worked Example
Why Amortization Matters for Your Finances
Understanding amortization helps borrowers realize how much interest they pay in early loan years, enabling strategic extra principal payments that cut thousands of dollars off total interest costs.
Common Misconception
Many borrowers falsely believe equal monthly payments mean equal principal reduction every month. In reality, interest costs dominate early payments.