### Consumer loans are different

For most consumer loans, such as home loans, education loans and car loans, things are different.

Take a mortgage loan, as an example.

A typical mortgage loan entails borrowing a very large sum of money. If the loan is structured the same way as the loans above, the borrower would have to pay a big lump-sum at the very end, which can be very difficult for most people to pay all of a sudden.

To avoid that, the loan is structured such that every month, the borrower pays the interest they owe (based on the outstanding principal and the rate of interest). And*,* a little bit of principal owed.

The following month, the outstanding principal is reduced slightly (due to the small principal payment the previous month). So the interest for that month is reduced.

By following that pattern of payments, the borrower pays down the principal balance gradually every month and no lump-sum payment is required at the very end.

This process of paying off the principal over time is what is called *Amortization*.

### Wait, weren’t we talking about “killing” something?

Precisely. If you think about it, by doing what we described above, the borrowers pay off their principal slowly.

In essence, they “kill” the principal balance little by little every month, like death by a thousand 360 cuts.

You see the link now?

### Ok, we have an answer to “what” and “why”. What about “how”?

Well, we already know a little bit of the “how”. What still continues to intrigue some of us is the question below:

*The borrower has a different amount of interest payment every month (given principal is changing every month), a different principal reduction amount every month and yet at the end of the loan term, the principal balance just magically becomes zero. And all of this, while the borrower is making exactly equal monthly payments for the duration of the loan. That sounds quite mysterious.*

It’s a very apt question. How is it that there are many moving parts (i.e. principal and interest, the balance) with each month’s interest being dependent on the previous month’s principal. Yet the one thing that does not change is the monthly payment.

How is the lender able to come up with that magical monthly payment number such that all of this just works perfectly?

As long as you make an equal monthly installment payment, you are taking care of all of the following:

- Paying the interest that is owed
- Reducing the principal gradually
- Left with no principal at the end of the loan term.