When loan payments are amortized, what happens to the total amount you owe every month?

• A. It decreases over time as principal is paid down.
• B. It increases each month due to accumulating interest.
• C. It fluctuates randomly based on market rates.
• D. It remains the same each month.

Answer: (A)

Verified step by step guidance

1. Understand the concept of loan amortization: Loan amortization refers to the process of paying off a loan over time through regular payments. Each payment includes both interest and principal components.
2. Recognize how the principal and interest components change: In the early stages of the loan, a larger portion of the payment goes toward interest, while a smaller portion goes toward reducing the principal. Over time, as the principal decreases, the interest portion of the payment decreases, and the principal portion increases.
3. Analyze the total monthly payment: For most amortized loans (e.g., fixed-rate mortgages), the total monthly payment remains constant throughout the loan term. However, the allocation between interest and principal changes as described above.
4. Determine the impact on the total amount owed: Since the principal is being paid down with each payment, the total amount owed decreases over time. This is a key characteristic of amortized loans.
5. Eliminate incorrect options: The total amount owed does not increase each month (as interest is not accumulating without payment), it does not fluctuate randomly (as fixed-rate loans have predictable payments), and the total amount owed does not remain the same (as principal is being reduced).