Amortization refers to the process of decreasing an amount over a period of time. It is a way of accounting for the said amount. Amortization can refer to a variety of applications, but the most common way that it is used is in relation to loans. In this context, amortization refers to the repayment of a loan over a predetermined period. The determining factor here is the way the repayment is structured.
The origins of the word amortization are quite interesting. It is rooted in the Middle English word amortisen, which means to kill. The Latin root is admortire, which has the same meaning. It is easy to draw the link between to kill or death and the current use of amortization - to kill off a debt by making regular payments.
The term amortized loan is used to refer to loans which follow a structured repayment scheme. A common exampled of an amortized loan is a house or home loan. If you scout the market for a home loan, you will encounter amortization calculators. This is a service that lenders offer their potential clients so that the latter will have an idea of just how much they will have to pay towards the loan every month. More often than not, payments are fixed monthly, although there may be cases wherein the last payment may be less or more than the regular amounts.
How are amortized payments calculated? The loan principal is divided by the number of months the loan is going to be paid off. This gives the base monthly payments. The next step is to add the interest, which is calculated based on different factors, including the length of the repayment period.