Massachusetts Real Estate License Practice Test

What does amortization refer to in the context of loans?

1. Increase of loan balance over time

2. Reduction of loan by equal payments

3. Complete repayment in one lump sum

4. Transfer of loan to another party

The correct answer is: Reduction of loan by equal payments

Amortization refers to the process of gradually reducing a loan balance through a series of regular, fixed payments over a specified period of time. In this context, each payment typically consists of both principal and interest, which allows the borrower to pay down the amount borrowed slowly until the loan is fully paid off. This method provides borrowers with the ability to manage their finances better, making it easier to budget for periodic payments. Other options reflect different concepts related to loans. For instance, increasing the loan balance over time does not describe amortization; rather, this could indicate the accrual of interest without payments being made. A complete repayment in one lump sum does not capture the gradual nature of amortization; this would be a different type of loan payoff. Lastly, transferring a loan to another party refers to loan assumption or assignment, which does not pertain to how the balance of the loan itself is reduced over time. Understanding amortization is crucial for both borrowers and real estate professionals, as it influences monthly budgeting and loan planning.