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What Is Amortization?

Learn about amortization in this Howcast finance video with expert Gregory McGraime.


Amortization is the process, when you're borrowing money, of spreading out the interesting principle payments over the term of the loan. So let me explain what I mean, because a lot of times when you're borrowing money, you're paying a simple interest rate, either on a monthly basis or a yearly basis. With an amortized loan, you're spreading that principle and interest payment throughout the term. And the perfect example of this that impacts so many people is their mortgage. Your mortgage is an amortization type of calculation, where in the beginning of a mortgage you're paying a lot more interest and only a small amount of principle. Towards the end of the mortgage, what happens? The opposite is true. Most of your payment is made up of principle and a small amount of interest. Now this impacts people in a lot of ways. For one, most people change their mortgages every five to seven years, either by refinancing to a new mortgage, or by moving. And so what does that mean? It means a lot of times you're stuck in the high interest portion of that payment. Number two. As you're trying to figure out what to do, whether you should refinance to a new mortgage and get a lower rate, refinancing in the early part of a mortgage can save you a lot more money because so much of your payment is interest. Whereas, towards the end of a loan, if I had a loan for 25 years and I want to refinance, even if I'm going to get a lower interest rate, the benefit to me may be pretty minimal. So just be aware as you're looking at the different types of debts that you have, particularly on your mortgage, at the difference between an amortizing loan versus a simple interest type of calculation loan, and how that might impact your bottom line.

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