Interest, Amortization & Interest Only vs. Amortization

I have always described interest as “rent on money”. When you take out a loan, you are renting money. The interest is the rent. The more you owe, the more rent you pay. The less you owe, the less rent you pay. Interest paid on real estate loans is usually tax deductible (consult with your tax advisor). If you make payments with both interest and additional funds to apply toward the principal, this is called an AMORTIZED payment, or AMORTIZATION. Car loans are almost always amortized loans. If a portion of your payment is principal, and you make the same monthly payment, your payments are first applied to the interest or rent on the money still owed, and the rest to principal. Since you only pay interest on the amount of your balance, as you pay down your loan balance with your monthly principal payments (in addition to the interest), less of your monthly payment goes to pay the interest (because every month you owe less) and more of your payment applies to your principal, paying your loan down faster and faster each month. Just like a car loan. After a period of time, you owe nothing; your loan is paid off.

An interest only loan means you only have to pay the interest due each month, BUT you have the option of adding extra funds to your interest payment to be applied to principal which lowers your principal balance, therefore lowering your monthly interest charges. An amortized payment requires you to pay principal as well as your interest each month. In either event, you are only charged interest on the amount of your principal balance. Any extra money paid over and above your monthly interest charge is applied to pay down your principal balance, resulting in lower interest charges the following month.