Legal Definitions - amortized loan

An amortized loan is a type of loan where the borrower makes regular, scheduled payments that gradually pay off both the principal amount borrowed and the interest accrued over a predetermined period. Each payment typically includes a portion that goes towards reducing the principal and a portion that covers the interest. Over the life of the loan, the proportion of each payment allocated to interest decreases, while the proportion allocated to principal increases, ensuring the loan is fully paid off by the end of its term.

• Example 1: Home Mortgage

  Imagine a couple purchases a home with a 30-year fixed-rate mortgage. They agree to make the same monthly payment for the entire 30-year term. In the early years, a significant portion of each payment goes towards covering the interest on the large loan amount. As time progresses, a larger share of their monthly payment is applied to reducing the actual principal balance of the loan. By the end of the 30 years, their regular payments will have fully paid off both the original amount borrowed for the house and all the accumulated interest, demonstrating an amortized loan structure.

• Example 2: Car Loan

  A person takes out a 5-year loan to buy a new car. The loan agreement specifies a fixed monthly payment for 60 months. Each of these payments is carefully calculated to cover both the interest charged by the lender and a portion of the original car price. With every payment, the outstanding principal balance decreases, and by the end of the five-year term, the car is entirely paid off, illustrating the predictable, complete repayment of an amortized loan.

• Example 3: Small Business Equipment Loan

  A small business owner secures a 7-year loan to purchase new manufacturing equipment. The loan terms require consistent monthly payments over the seven-year period. These payments are structured so that they not only cover the interest on the borrowed capital but also steadily reduce the principal amount of the loan. This predictable repayment schedule allows the business to budget effectively and ensures that the equipment is fully owned and paid for by the end of the seven-year term, which is a clear characteristic of an amortized loan.