Money Minutes: Amortization

We know time is precious, and that you don’t want to waste too much of it attempting to wrap your head around financial know-how. Educating yourself about money, though, is crucial to cutting the stress and potential mess in dealing with your money matters. Our Money Minutes posts help you make sense of personal finance and money-related definitions, concepts, and advice that can be tricky and confusing to break down. We’ll help you make better sense of it in just a few short minutes! Today’s topic is:

Amortization

If you’ve purchased a car or a home before, you’ve likely heard the term Amortization, but if you still don’t fully understand what it means, you’re not alone.

Brief Breakdown

In short, Amortization refers to “the systematic payment plan – such as a monthly payment – so that your loan is paid off over the specified loan period.” An amortized loan, then, is a loan for a set amount of money that is to be paid off by a specific date, typically in equal, monthly installments. The word actually arises from a Latin term meaning, “to deaden,” but experts agree that the common phrase – “gradual extinguishment” - attached to the dictionary definition better suits the term. Amortization also refers the relationship between interest in principal – as you start paying first on the interest and gradually pay more on the principal.

What That Means for You

If you decide to take out a mortgage or buy a new vehicle, you’ll likely be dealing with an amortized loan. You can expect to spend several months or years making payments – initially toward the interest and, gradually, more on the principal – to pay off your loan. You can expect a set, monthly payment and a set date to have your loan paid off. Should you decide you’d like to quicken the “gradual extinguishment" of your loan, for instance, if your financial situation has improved (you’ve gotten a raise or paid off other debts), you can increase your monthly payments so that you’ll see your payoff date sooner.

Examples

Installment loans, like what you’d take out for a house or a car, are examples of amortized loans. You have a set monthly payment and a loan period – be it 12 months, 60 months, etc. A credit card would not be considered an amortized loan, because it’s revolving and there is no fixed payoff date.

• Free Amortization Schedule Calculator.
• Investopedia Amortization Page

Credit for the information provided in this article goes to  BankRate.