What is amortization
Amortization means paying off a debt through regular instalments, where each instalment covers the interest due for that period plus a part of the principal (the amount originally borrowed).
When the last instalment is paid, the outstanding balance reaches zero. A loan that works this way is called an amortizing loan.
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Worked example: a hypothetical car loan
Sara borrows money from a bank to buy a car. The loan has a fixed rate and equal monthly instalments over an agreed term. Each month the bank does the same calculation:
- Interest part = outstanding balance × monthly interest rate
- Principal part = fixed instalment − interest part
- New balance = old balance − principal part
Each payment lowers the balance, so the interest part shrinks over time and the principal part grows, even though the instalment stays the same.
| Stage of the loan | Interest share of instalment | Principal share of instalment | Outstanding balance |
|---|---|---|---|
| Early months | Large | Small | Close to the amount borrowed |
| Middle of the term | Roughly balanced | Roughly balanced | About half repaid |
| Final months | Small | Large | Near zero, then zero |
The month-by-month table the bank gives Sara is called an amortization schedule. It lists every instalment date, the interest and principal parts, and the balance left after each payment.
Where the term appears
- Bank and house finance documents: the repayment plan attached to a loan offer is usually an amortization schedule.
- Company reports: "amortization" is also the accounting term for spreading the cost of an intangible asset, such as software or a licence, over its useful life. This is the "A" in EBITDA.
- Bonds: an amortizing bond repays part of its face value along with each coupon. In accounting, a premium or discount paid on a bond is amortized over its remaining life.
- News on public debt: reports on Pakistan's external debt often mention "amortization payments", meaning principal repayments falling due, as distinct from interest payments.
Precise definition and edge cases
Formally, amortization is the scheduled reduction of a liability, or of an asset's carrying value, through periodic charges until it reaches zero or its residual value.
Cases where the simple picture does not hold:
- Floating rate loans: many Pakistani loans are priced as KIBOR plus a margin. When rates change, the bank recalculates the instalment or the term. For reference, the latest SBP decision: SBP policy rate raised by 50 bps to 12% with effect from 27.10.2026 (MPC). Rate moves are often quoted in basis points.
- Interest-only period: for a set time, only interest is paid and the principal does not fall.
- Balloon payment: the instalments do not fully repay the loan, so a large final payment clears the rest.
- Negative amortization: the instalment is smaller than the interest due, so the unpaid interest is added to the balance and the debt grows.
- Prepayment: an extra payment toward principal cuts future interest. The bank may charge a prepayment fee, so read your loan terms.
- Islamic finance: diminishing musharakah and similar structures use a repayment table that looks like an amortization schedule but is built from rent and the purchase of ownership units. See Islamic finance.
Margin used in leveraged CFD or forex trading is not an amortizing loan. Losses there can exceed what a trader expects and can come fast.
Related terms
- Accrued interest
- Future and present value
- Bond duration
- Default
- Collateral
- Saving, Investing, Loans
- Trading glossary
Frequently asked questions
What does amortization mean in simple words?
It means repaying a debt in instalments that cover both interest and part of the amount borrowed, until nothing is owed.
What is an amortization schedule?
It is a table listing each instalment with its interest part, principal part and the balance remaining after the payment.
Why is so much of my early instalment interest?
Interest is charged on the outstanding balance, and the balance is highest at the start of the loan.
Is amortization the same as depreciation?
They are similar ideas. In accounting, depreciation applies to physical assets and amortization applies to intangible assets.
Can the balance go up even if I pay every month?
Yes, under negative amortization, when the instalment is smaller than the interest charged for the period.