Amortization
Amortization is the process of gradually paying off a debt over time through scheduled, periodic payments that cover both principal and interest. This is evaluated within Revolving Credit vs Installment Credit.
Plain-Language Meaning
Amortization refers to spreading out loan payments over a set period, so that each payment reduces the amount owed and pays interest, until the debt is fully repaid.
Practical Example
If you take out a car loan, you make monthly payments that are calculated to pay off both the amount you borrowed and the interest, so by the end of the loan term, you owe nothing more.
What It Does Not Mean
Amortization does not refer to making random or unscheduled payments, nor does it apply to revolving credit accounts like credit cards, which do not have fixed repayment schedules.
How It’s Calculated
The system calculates amortization by determining a fixed payment amount for each period, based on the loan amount, interest rate, and repayment term, ensuring that the loan is fully paid off by the end of the term.
Common Misconceptions
- “Amortization only covers interest payments.” Amortization includes both principal and interest in each payment.
- “Amortization applies to all types of credit.” Amortization is specific to installment loans, not revolving credit.
- “Amortization means paying off a loan early.” Amortization is the scheduled process of repayment, not early payoff.
Related Pages
Related Glossary Terms
FAQ
- Does amortization affect my credit score? Amortization itself does not directly affect your credit score, but making on-time payments on an amortized loan can have a positive impact.
- Can I change my amortization schedule? Some lenders allow you to adjust your payment schedule or make extra payments, but this depends on the loan agreement and lender policies.