# What Are Amortized Bonds? Definition, Mechanics, and Examples Explained

## What Is an Amortized Bond?

An amortized bond is one in which the principal (or face value) of the debt is paid down regularly, along with its interest expense, over the life of the bond. These bonds use an amortization schedule, which slowly transitions from paying more interest in the first half of the bond term to more principal in its second half. They reduce credit and interest rate risks.

A fixed-rate residential [mortgage](https://www.investopedia.com/terms/m/mortgage.asp) is a common example, as the monthly payment remains constant throughout its life, typically 30 years. However, each payment represents a slightly different percentage mix of interest vs. principal. An amortized bond is different from a [balloon](https://www.investopedia.com/terms/b/balloonloan.asp) or [bullet](https://www.investopedia.com/terms/b/bulletloan.asp) loan, where there is a large portion of the principal that must be repaid only at its maturity.

Two methods of amortization are used to amortize bonds: straight-line and effective-interest, which compute interest and principal payments differently.

### Key Takeaways

*   Amortized bonds pay both principal and interest over the bond's life, reducing credit risk with no large final payment.
*   Fixed-rate mortgages are a common example of amortized bonds with equal monthly payments.
*   Amortization minimizes interest rate risk by shortening the weighted-average maturity and duration of cash flows.
*   Two main amortization methods for bonds are the straight-line and effective-interest methods, affecting accounting differently.
*   An amortization schedule details how payments are divided between principal and interest over time.

## How Amortization Reduces Risk in Bonds

An [amortization schedule](https://www.investopedia.com/terms/a/amortization.asp) divides the principal of an amortized loan or bond into equal payments over time. Early loan payments mostly cover interest. As the loan matures, more payments go towards the principal. Amortizing loan calculations resemble those for annuities and can be done quickly with an [amortization calculator](https://www.investopedia.com/amortization-calculator-5086959).

Amortizing debt reduces credit risk because the principal is repaid gradually, not all at once at maturity. It also shortens the bond's duration, making it less sensitive to [interest rate](https://www.investopedia.com/terms/i/interestraterisk.asp) changes than non-amortized debt. Over time, interest payments decrease, reducing the [weighted-average maturity](https://www.investopedia.com/terms/w/weightedaveragematurity.asp) (WAM) of the bond's cash flows.

## Practical Example: Amortization in a 30-Year Mortgage

30-year fixed-rate mortgages are amortized so that each monthly payment goes towards interest and principal. Say you purchase a home with a $400,000 30-year fixed-rate mortgage with a 5% interest rate. The monthly payment is $2,147.29, or $25,767.48 per year.

After year one, 12 payments are mostly interest, only $3,406 of principal is paid, leaving $396,593 as the balance. In year two, the principal paid grows to $6,075. By year 29, $24,566 of the annual payments go towards the principal. Free [mortgage calculators](https://www.mortgagecalculator.org/) or amortization calculators are easily found online to help with these calculations quickly.

## Straight-Line vs. Effective-Interest: Choosing an Amortization Method

Companies issuing bonds use amortization to treat [bond discounts](https://www.investopedia.com/terms/b/bond-discount.asp) as assets until maturity. A bond sells at a discount if below [face value](https://www.investopedia.com/terms/f/facevalue.asp), and at a premium if above.

[Discounts](https://www.investopedia.com/terms/a/at-a-discount.asp) on bonds issued below face value can be expenses or amortized as assets for tax purposes, affecting a company's interest expense. Interest expense lowers a company's [earnings before tax](https://www.investopedia.com/terms/e/ebt.asp) (EBT), reducing its tax burden.

> **Fast Fact**
>
> Amortization is an accounting method that gradually and systematically reduces the cost value of a limited-life, intangible asset.

Bond premiums or discounts can be amortized using effective-interest or straight-line methods. The straight-line method, where annual bond discount amortization is equal throughout, is the simplest to use.

Companies may also issue amortized bonds and use the [effective-interest method](https://www.investopedia.com/ask/answers/063015/what-effective-interest-method-amortization.asp). Rather than assigning an equal amount of amortization for each period, effective-interest computes different amounts to be applied to interest expense during each period. Under this second type of accounting, the bond discount amortization is based on the difference between the bond's [interest](https://www.investopedia.com/terms/i/interest.asp) income and its interest payable. The effective-interest method requires a financial calculator or spreadsheet software to derive.

## The Bottom Line

An amortized bond pays interest and principal over time, unlike balloon or bullet loans, which require large, timed payments. Amortization schedules divide payments evenly, applying portions to interest or principal based on bond maturity. Two schedules used to amortize bonds are the straight-line and effective-interest methods, which break down principal and interest differently.

Knowing amortized bonds aids in tax planning, preparing financial statements, and making investment decisions.