Glossary term
Amortized Loan
An amortized loan is repaid through scheduled payments that cover interest and gradually reduce principal over the loan term.
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What Is an Amortized Loan?
An amortized loan is repaid through scheduled payments that cover interest and gradually reduce principal over the loan term. If the loan fully amortizes, the balance reaches zero by the final scheduled payment.
Most standard mortgages, auto loans, and personal installment loans are amortized loans. The payment may look level, but the mix of interest and principal changes over time.
Key Takeaways
- An amortized loan is paid down through scheduled payments over time.
- Each payment usually includes both interest and principal.
- Early payments often go more heavily toward interest.
- Later payments usually reduce principal faster.
- An amortized loan is different from an interest-only loan or a negative-amortization loan.
Amortized Loan Payment Formula
For a fully amortizing fixed-rate loan, the payment formula is often written as:
In the formula, PMT is the scheduled payment, P is the loan principal, r is the periodic interest rate, and n is the number of payments.
How an Amortized Loan Works
At the beginning of the loan, more of each payment often goes toward interest because the outstanding balance is larger. As the balance falls, less interest accrues each period, and more of each payment can reduce principal.
This is why the balance may seem to fall slowly at first and faster later. The payment schedule is doing two jobs at once: paying current interest and reducing the amount owed.
Amortized Loan Versus Interest-Only Loan
An interest-only loan requires payments that cover only interest for a period of time, so the principal balance does not fall during that period. An amortized loan is structured to reduce principal as payments are made.
An amortized loan is also different from negative amortization, where unpaid interest can be added to the loan balance and the amount owed can grow instead of shrink.
Where Borrowers See Amortized Loans
Borrowers often see amortized loans in mortgages, auto loans, student loans, and installment loans. The amortization schedule shows how each payment is split between interest and principal and how the balance is expected to decline.
The Bottom Line
An amortized loan is repaid through scheduled payments that cover interest and gradually reduce principal. The structure can make payments predictable, but borrowers still need to understand how rate, term, and payment size affect the total interest paid.