Finance & Mortgages

Amortization

The gradual repayment of a loan through scheduled periodic payments that cover both principal and interest.

Full Definition

Amortization is the process of repaying a loan over time through regular payments, each of which covers a portion of the interest accrued and a portion of the principal balance. In the early years of an amortized loan, most of each payment is applied to interest (because interest is calculated on the outstanding balance). As the principal decreases over time, less of each payment goes to interest and more goes to principal reduction. A fully amortized loan is paid off in full by the final scheduled payment. Common amortization periods in real estate are 15 and 30 years. The monthly payment formula is: M = P[r(1+r)^n] / [(1+r)^n - 1].

Real-World Example

On a $300,000 loan at 7% for 30 years, the monthly payment is $1,996. In month 1, about $1,750 goes to interest and $246 to principal. By year 25, more goes to principal than interest.

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How Amortization Appears on the Real Estate Exam

Common question types, tested concepts, and what to watch out for

Know that early payments are mostly interest — this is 'front-loading' of interest. Understand the difference between fully amortized (pays off at term), partially amortized (balloon payment), and interest-only loans.