What does the term "amortization" refer to?

Amortization refers to the process of gradually paying off a loan over a specified period through regular payments. These payments typically cover both the principal amount borrowed and the interest on the loan. As the borrower makes monthly payments, they gradually reduce the outstanding balance of the loan. This structured repayment approach allows borrowers to understand their financial obligations over the life of the loan, ensuring that by the end of the amortization period, the loan is fully paid off.

The concept of amortization is often detailed in an amortization schedule, which outlines each payment's breakdown into principal and interest over the duration of the loan. It’s essential for borrowers to grasp this concept, as it impacts their monthly budgeting and overall financial planning. Understanding amortization helps in assessing how loan terms and interest rates will affect the total cost of borrowing and the time needed to pay off a debt completely.