Future Business Leaders of America (FBLA) Agribusiness Practice Test

In what form can amortization occur?

1. Equal principal payments or equal total payments

2. Only in equal principal payments

3. Only as a lump-sum payment upon term maturity

4. Variable payments based on market rates

The correct answer is: Equal principal payments or equal total payments

Amortization refers to the process of spreading out a loan into a series of fixed payments over time. The correct answer encompasses two common forms of amortization: equal principal payments and equal total payments. Equal principal payments involve paying back a fixed amount of the principal with each payment, resulting in decreasing interest costs over time because the principal balance is reduced with each payment. Consequently, while the principal payment remains constant, the overall payment to the lender decreases as the interest amount reduces with the diminishing principal. On the other hand, equal total payments maintain a consistent payment amount throughout the term of the loan. This structure combines both principal and interest in a way that ensures the total payment remains the same, although the breakdown between principal and interest will vary over time. These two methods provide flexibility in managing loan repayment, aligning with the financial preferences and situations of different borrowers, making option A the most comprehensive choice regarding the forms amortization can take.