As the months progress on an amortized loan, which of the following statements is true regarding the composition of each monthly payment?

• A. The portion of the payment applied to interest increases, while the portion applied to principal decreases.
• B. Both the interest and principal portions of the payment remain constant throughout the loan term.
• C. The total monthly payment amount increases over time.
• D. The portion of the payment applied to interest decreases, while the portion applied to principal increases.

Answer: (D)

Verified step by step guidance

1. Step 1: Understand the concept of an amortized loan. An amortized loan is a type of loan where the borrower makes regular payments that cover both the interest and a portion of the principal balance. Over time, the loan is paid off in full through these payments.
2. Step 2: Recognize how interest is calculated on an amortized loan. Interest is typically calculated based on the remaining principal balance. At the beginning of the loan term, the principal balance is higher, so the interest portion of the payment is larger.
3. Step 3: Analyze the composition of monthly payments. Each monthly payment is fixed in amount, but the allocation between interest and principal changes over time. As the principal balance decreases due to payments, the interest portion of the payment decreases.
4. Step 4: Understand the shift in payment composition. As the interest portion decreases, the portion of the payment applied to the principal increases. This is because the fixed monthly payment must cover less interest, allowing more of the payment to go toward reducing the principal.
5. Step 5: Conclude that over the life of an amortized loan, the portion of the payment applied to interest decreases, while the portion applied to principal increases. This is a key characteristic of amortized loans.