How Does an Amortizing Loan Work?

An amortizing loan is one where the borrower pays off the loan on a schedule, usually paying on both the principal and the interest at the same time. If you’ve had an auto loan, mortgage, or other types of personal loans, odds are you’ve had an amortizing loan. 

Amortization is a fancy way of describing a loan that is paid off through regular payments. The other important thing to remember about an amortizing loan is that each payment will go toward paying off the interest as well as the principal. The principal is simply the amount of money you initially borrowed. The interest is the cost of borrowing that money. 

If your loan is on an amortization schedule, then you’re making regular payments (probably monthly). Your monthly payment will first go toward paying off the accrued interest for that time period, then the remainder will be applied to the principal. Since your principal balance will get lower as you continue to make payments, the interest will as well. 

Over time, the interest portion of your payment will continue to get smaller. This means less of your monthly payments will have to go toward the interest, and more will go to paying off the principal amount. By the end of the amortization schedule, you will have paid off all of the interest, as well as the entire principal amount. At this point, the loan contract has been fulfilled and the loan has ended. If you made payments on time and paid off the loan by the due date then you may have even boosted your credit score a bit. 

Whether you’re considering a loan with an amortization schedule or another type of loan, the important thing to keep in mind is whether you pay on time or not will directly affect your credit score. Consistent on-time payments can boost your credit score while missing payment or paying late can negatively affect your score.