If you’re taking out a loan—whether for a home, car, or something else—understanding amortization is essential. Here are five important terms you’ll see over and over when it comes to amortized loans:
1. Principal
Principal is the original amount you borrow from the lender. For example, if you get a $250,000 mortgage, the principal is $250,000. Each loan payment you make reduces the principal, little by little.
2. Interest
Interest is the cost of borrowing money, usually shown as a percentage (the interest rate). With every payment, a portion goes to paying off interest. Early in your loan, most of your payment goes to interest—later, more goes toward principal.
3. Monthly Payment
Your monthly payment is the fixed amount you pay each month to the lender. This payment includes both principal and interest. Over time, the principal portion increases, and the interest portion decreases.
4. Amortization Schedule
An amortization schedule is a table that shows each monthly payment, breaking down how much goes toward interest, how much to principal, and the remaining loan balance after each payment. This schedule helps you see how your loan gets paid off over time.
5. Loan Term
The loan term is the total length of time you have to repay your loan—often 15, 20, or 30 years for mortgages. The longer your loan term, the smaller your monthly payments—but you’ll pay more interest over the life of the loan.