Ever wonder where your monthly loan payment goes? Amortization explains how each payment is split between principal and interest over the life of your loan.
What Is Amortization?
Amortization is the process of paying off a loan through regular, fixed payments over time. Each payment covers both interest charges and reduces the principal balance.
Key concept: Early payments are mostly interest. Later payments are mostly principal. This is by design, not accident.
How Amortization Works
Example: $200,000 mortgage at 6% for 30 years, monthly payment: $1,199
Month 1:
- Interest: $1,000 (6% ÷ 12 × $200,000)
- Principal: $199 ($1,199 - $1,000)
- Remaining balance: $199,801
Month 2:
- Interest: $999 (slightly less because balance is lower)
- Principal: $200 (slightly more)
- Remaining balance: $199,601
Month 360 (final):
- Interest: $6
- Principal: $1,193
- Remaining balance: $0
The Amortization Formula
Monthly Payment = P × [r(1+r)^n] / [(1+r)^n - 1]
Where: P = principal, r = monthly rate, n = number of payments
Why Early Payments Are Mostly Interest
Interest is calculated on the remaining balance. At the start:
- Balance is highest → Interest is highest
- Fixed payment - high interest = low principal reduction
Over time:
- Balance decreases → Interest decreases
- Fixed payment - low interest = high principal reduction
Types of Amortizing Loans
- Mortgages: 15, 20, or 30-year terms
- Auto loans: Typically 36-72 months
- Personal loans: Usually 12-60 months
- Student loans: Often 10-25 years
Reading an Amortization Schedule
An amortization schedule shows every payment over the loan's life:
| Month | Payment | Principal | Interest | Balance |
|---|---|---|---|---|
| 1 | $1,199 | $199 | $1,000 | $199,801 |
| 60 | $1,199 | $248 | $951 | $187,432 |
| 180 | $1,199 | $432 | $767 | $151,203 |
| 360 | $1,199 | $1,193 | $6 | $0 |
The Power of Extra Payments
Making extra payments dramatically reduces interest and loan term.
$200,000 mortgage at 6% for 30 years:
- Regular payments ($1,199/month): Pay $231,640 in interest over 30 years
- Extra $200/month: Pay $160,471 in interest over 21 years
- Savings: $71,169 and 9 years!
Strategies to Pay Off Faster
1. Extra Principal Payments
Any extra payment goes 100% to principal, immediately reducing future interest.
2. Biweekly Payments
Pay half your monthly payment every two weeks. This results in 13 full payments per year instead of 12.
3. Round Up Payments
$1,199 → round to $1,250. Small amount makes big difference over time.
4. Lump Sum Payments
Use bonuses, tax refunds, or windfalls for principal-only payments.
Negative Amortization
Warning: Some loans allow payments less than interest due. This causes the balance to GROW instead of shrink. Avoid these loans!
Amortization vs. Simple Interest
Amortized loans: Fixed payments, changing interest/principal split
Simple interest: Interest calculated only on original principal (rare for loans)
Key Takeaways
- Early payments are mostly interest, later payments mostly principal
- This is normal and intentional in loan design
- Extra payments go directly to principal
- Even small extra payments save thousands in interest
- Amortization schedules show the full repayment breakdown
- Shorter loan terms = less total interest paid
Understanding amortization helps you see how loans really work and how to pay them off faster. Use our loan calculator to see your own amortization schedule.