How is interest calculated on an amortizing loan?

Interest on an amortizing loan is calculated based on the remaining loan balance, which means that each month, the interest is determined by taking the current outstanding balance of the loan and applying the interest rate to it. This interest amount is added to the principal repayment to form the total monthly payment.

As the loan is paid down over time, the remaining balance decreases, and therefore, the amount of interest calculated for subsequent months also decreases. This structure allows borrowers to build equity in their property while gradually reducing their debt, as they pay both interest and principal every month.

The other options do not accurately reflect how interest is calculated on an amortizing loan. For instance, calculating interest based on the total amount borrowed would ignore the principle of amortization and not account for the decreasing balance over time. Similarly, a fixed percentage on the initial loan amount does not consider how the debt is repaid throughout the loan term. Lastly, interest assessed solely at the end of the term as a balloon payment does not align with the regular payment structure typical of amortizing loans, where payments are made throughout the loan's life.