Future Business Leaders of America (FBLA) Business Calculations Practice Test

What does it mean to amortize a loan?

1. To cancel a loan after a specified number of equal payments

2. Pay off a loan in a specified number of unequal payments

3. To cancel a loan after a specified number of unequal payments

4. Pay off a loan in a specified number of equal payments

The correct answer is: Pay off a loan in a specified number of equal payments

To amortize a loan refers to the process of gradually paying off the loan through a series of scheduled, equal payments over a designated period. Each payment typically includes both principal and interest components. The primary intention of amortization is to ensure that, by the end of the loan term, the borrower has completely repaid the initial loan amount plus any incurred interest. This concept plays a crucial role in various types of loans, such as mortgages or car loans, as it helps borrowers understand their financial commitments over time. By having equal payments, borrowers can more easily budget and plan for their future payments, as the amount they are required to pay does not change throughout the loan term. Additionally, the amortization schedule provides a clear view of how much of each payment is going toward interest versus the principal, highlighting the gradual reduction of the debt. In contrast, the other options involve concepts like unequal payments or specific cancellation conditions, which do not align with the standard definition of loan amortization. Therefore, the focus on equal payments is what makes the correct understanding of amortization clear and significant in financial management.