Amortization is paying off debt over a period of time with a fixed repayment schedule in regular installments. Monthly mortgage payments are often comprised of primarily interest at the beginning of the loan term, with the principal component increasing with each subsequent payment.
For example, a $100,000 mortgage with a 5.0% interest rate and 30-year amortization schedule would consist of monthly payments of $536.82. The month one payment would allocate $416.67 to interest ($100,000 balance multiplied by the 5.0% interest rate divided by 12 months) and the balance of $120.15 would be applied toward principal reduction.
In month two, the principal balance would be reduced to $99,879.85 ($100,000 beginning balance less the $120.15 principal payment from month one) and the monthly payment would be allocated $416.17 to interest ($99,879.85 balance multiplied by the 5.0% interest rate divided by 12 months) and the balance of $120.65 applied toward principal reduction.
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