Amortization is the process of gradually paying off a loan through regular payments over a specified period. Each payment consists of both principal and interest. The term ‘amortization’ can also refer to the spreading out of the cost of an intangible asset over its useful life.
In the context of a loan, an amortization schedule outlines each payment’s allocation between principal and interest. Initially, a larger portion of the payment goes towards interest, but over time, as the principal is reduced, a larger portion of the payment goes towards the principal. For example, in a 30-year mortgage, the early payments are primarily interest, but by the end of the term, the payments are mostly principal.
Amortization is beneficial for borrowers because it allows them to understand how their payments are structured and how the loan balance will decrease over time. It is also useful for investors and businesses, as it provides a clear picture of how the cost of an intangible asset, such as a patent or trademark, is spread out over its useful life, impacting financial statements and tax calculations.