What does the term "amortization" refer to?

Amortization refers to the gradual reduction of a loan balance through scheduled payments, which encompasses both principal and interest components. In an amortized loan, borrowers make regular payments over a specified period, and each payment contributes to reducing the overall principal amount owed while also covering interest charges. This systematic strategy makes it easier for borrowers to manage their finances and understand how much they owe at any point during the term of the loan.

For instance, in a typical mortgage or personal loan, the amortization schedule details each payment over time and how it affects the outstanding balance. As payments continue, a larger portion goes towards the principal, gradually decreasing the loan amount until it is fully paid off by the end of the term. This process is crucial for effective financial planning and helps borrowers track their debts more efficiently.