Definition
Amortisation is the process of paying off a loan through regular repayments that cover both interest and principal, so the balance reduces to zero by the end of the term. Early repayments contain more interest and later ones more principal. Balloon payments and interest-only periods slow amortisation, leaving more of the balance outstanding for longer.
Amortisation describes how a loan shrinks over time.
How it works
On a standard principal-and-interest loan, each repayment covers the interest charged since the last repayment, and the remainder reduces the principal. The balance is biggest at the beginning, so the first instalments go largely on interest and the final ones largely reduce the debt. By the final repayment, the balance is zero.
What changes it
An interest-only period means no principal is repaid for a time. A balloon leaves part of the principal unpaid until the end. Both lower repayments now and increase what is owed later.
Why it matters
Understanding amortisation helps you see how much you will owe at any point, which matters if you plan to sell an asset or refinance. Our guide to how business loans work puts it in context. For finance structured to suit you, make one enquiry.
Common questions
Why does my balance fall slowly at first?
On a reducing-balance loan, early repayments include more interest because the balance is highest at the start. More of each repayment goes to principal over time.
Does amortisation apply to factor-priced loans?
Not in the same way. Factor pricing fixes the total cost upfront, so the balance does not reduce on a reducing-balance basis.
Sources and further reading
Related terms