Amortization
Standard Definition
The gradual liquidation or repayment of a financial debt through regular, periodic payments of both principal and interest over a specified term.
Detailed Examination Analysis
Amortization is the structural method by which most mortgages are paid off. In a fully amortized loan, the borrower pays equal monthly payments. In the early years of the mortgage, the majority of each payment goes toward paying off the interest, with a small portion going toward reducing the principal. As the outstanding loan balance decreases over time, the interest portion of the monthly payment decreases, and the amount allocated to the principal increases until the loan balance reaches zero at the end of the term.
Real-World Examination Scenario
"An agent helps a buyer secure a 30-year fixed-rate mortgage of $300,000. With a fully amortized loan schedule, the buyer makes equal monthly payments of $1,800. In month 1, $1,500 goes to interest and $300 to principal. By year 25, $300 goes to interest and $1,500 goes directly to reducing the principal balance."
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