Amortization is the mathematical equation at the core of a fixed-rate mortgage or other loan. This term describes the process in which the loan principal (the original amount of debt) decreases over the life of the loan. Each payment reduces both the principal and the total anticipated interest of the loan.
The word “amortization” derives from the Middle English “amortisen,” which means “to kill” referring to the process by which the debt is “killed” over time. (Incidentally, the word “mortgage” comes from the Old French words “mort,” for death, and “gage,” for pledge. Many home owners may agree that signing a mortgage feels like a “death pledge.”)
The amortization process allows individuals and businesses to borrow money for large purchases and be able to pay off the debt over time. It puts home buying within reach of most working class citizens and provides businesses necessary funds for expansion, equipment, and other investments.
Fixed rate loans allow borrowers to budget a fixed monthly payment without having to compensate for the abrupt changes that adjustable rate loans bring. While fixed rate loans do offer many benefits, one of the disadvantages is that the buyer ends up paying a great deal more interest than if they had initially paid a majority of the principal.