Definition
Amortization is a process of spreading out interest and principal payments on a debt that is to be paid back in equal installments over the life of the loan.
Analysis
An installment loan amortizes the debt over equal installments, spreading the interest cost over the life of the loan. As the loan balance is reduced, the amount of interest incurred also decreases.
The result is that initial payments are mostly interest with very little principal paid. Payments near the end of the loan are almost all principal, with very little interest included. By amortizing the loan, an installment payment amount can be calculated as well as the rate of the loan in its entirety, expressed as an annual percentage rate.
An amortization schedule is used to explain interest and principal payments made in each installment payment over the life of the loan.
