How does an amortized loan function?

An amortized loan functions by requiring both principal and interest to be paid in regular, periodic installments throughout the life of the loan. This means that each payment made reduces the outstanding balance of the loan while also covering the interest that has accrued. Over time, the proportion of the payment allocated toward the principal increases, while the portion allocated toward interest decreases, eventually leading to the loan being fully paid off by the end of the term.

This structured repayment schedule distinguishes amortized loans from other types of loans, such as balloon loans or interest-only loans, where payments may not contribute towards paying down the principal during the term. In an amortized loan, the consistent payment schedule helps borrowers plan their finances over time, making it a common choice for mortgages and auto loans.