Amortization means spreading a cost or repayment over time according to a schedule. In economics and finance, the word is used mainly in two ways: paying down a loan through regular installments, and allocating the cost of an intangible asset across its useful life.
Loan Amortization
For a fully amortizing loan, each payment includes interest plus some principal. Early payments contain more interest because interest is charged on a larger outstanding balance. Later payments contain more principal because the remaining balance is smaller.
For principal P, periodic interest rate r, and n equal payments, the fixed payment is:
[ \text{Payment} = P\frac{r(1+r)^n}{(1+r)^n - 1} ]
This formula matters because it links loan size, maturity, and interest rate to the borrower’s cash-flow burden.
Asset Amortization
In accounting, amortization also means expensing the cost of an intangible asset such as a patent, license, or software asset over the period in which it is expected to generate benefits. That keeps reported cost aligned more closely with the revenue or service flow produced by the asset.
Why It Matters Economically
Amortization affects household budgets, firm cash flow, and valuation. Faster loan amortization reduces credit risk because the outstanding balance falls more quickly. On the accounting side, amortization changes measured profit over time even when cash payments happened earlier.