What is Amortization?
Amortization is the process of spreading out a loan into a series of fixed payments over time. Each payment covers both the interest owed and a portion of the principal balance. Early payments are mostly interest; later payments are mostly principal.
Amortization applies to mortgages, auto loans, personal loans, and other installment debt with a fixed repayment schedule. Understanding your amortization schedule helps you see exactly where your money goes each month.
How Amortization Works
The Standard Amortization Formula
M = P × [r(1+r)^n] / [(1+r)^n - 1]
Monthly payment calculation
How Each Payment Breaks Down
Each monthly payment is divided between interest and principal:
- Interest portion = Outstanding balance × Monthly rate
- Principal portion = Total payment - Interest portion
- New balance = Old balance - Principal paid
As the balance decreases, less goes to interest and more to principal. This is why the split changes dramatically over the life of the loan.
Front-Loaded Interest
Amortization Schedule Example
Here's how payments might break down on a $300,000 mortgage at 6.5% for 30 years (monthly payment: $1,896):
| Year | Principal Paid | Interest Paid | Ending Balance |
|---|---|---|---|
| 1 | $6,350 | $16,405 | $293,650 |
| 5 | $37,695 | $76,085 | $262,305 |
| 10 | $86,680 | $141,100 | $213,320 |
| 15 | $149,700 | $189,075 | $150,300 |
| 20 | $230,760 | $218,015 | $69,240 |
| 30 | $300,000 | $382,633 | $0 |
Notice how interest dominates early years
Total Interest Shock
15-Year vs 30-Year Mortgage
Choosing between loan terms is one of the biggest financial decisions. Here's a comparison on a $300,000 loan at 6.5%:
| Factor | 15-Year | 30-Year | Difference |
|---|---|---|---|
| Monthly Payment | $2,613 | $1,896 | +$717 |
| Total Interest | $170,402 | $382,633 | -$212,231 |
| Total Paid | $470,402 | $682,633 | -$212,231 |
The 15-year loan saves over $212,000 in interest but costs $717 more per month. Choose the 15-year if you can comfortably afford it without sacrificing other goals.
The Best of Both Worlds
The Power of Extra Payments
Extra payments go directly to principal, reducing the balance and future interest:
| Extra Payment | Years Saved | Interest Saved |
|---|---|---|
| $100/month | 4.2 years | $48,000 |
| $200/month | 7.0 years | $79,000 |
| $500/month | 12.5 years | $138,000 |
| 1 extra payment/year | 3.5 years | $38,000 |
Based on $300,000 at 6.5% for 30 years
Best Times to Make Extra Payments
- Early in the loan when interest burden is highest
- When you get a raise, bonus, or windfall
- Tax refund season
- When you pay off other debts (snowball the payment)
Types of Amortizing Loans
Fixed-Rate Mortgage
Same interest rate and payment for the entire loan term. Most predictable option. Common terms are 15, 20, and 30 years.
Adjustable-Rate Mortgage (ARM)
Rate is fixed for an initial period (5, 7, or 10 years), then adjusts periodically. Lower initial rates but risk of payment increases later.
Auto Loans
Typically 3-7 year terms. Shorter terms mean higher payments but less total interest. Longer terms often come with higher rates.
Personal Loans
Usually 2-7 year terms. Often used for debt consolidation, home improvement, or major purchases. Fixed payments make budgeting easy.
Reading Your Amortization Schedule
| Column | What It Shows |
|---|---|
| Payment Number | Which payment in the sequence (1 through total) |
| Payment Amount | Your monthly payment (fixed for most loans) |
| Principal | How much of this payment reduces your debt |
| Interest | How much goes to the lender as interest charges |
| Remaining Balance | What you still owe after this payment |
Watching principal overtake interest in your schedule (usually around the midpoint) is a milestone worth celebrating — you're now gaining equity faster than paying interest.
Factors That Affect Your Amortization
- Interest rate — Even 0.5% higher rate adds thousands in interest over the loan life
- Loan term — Longer terms mean more total interest but lower monthly payments
- Principal amount — Borrowing less obviously reduces total cost
- Extra payments — Even occasional extra payments can save years and thousands
- Refinancing — A lower rate on your remaining balance restarts amortization but can save money
Frequently Asked Questions
Q: Why is most of my payment going to interest at first?
A: Interest is calculated on the remaining balance. With a large balance early on, the interest charge is high. As you pay down principal, less interest accrues, so more of your fixed payment goes to principal.
Q: Should I make extra payments or invest the money?
A: It depends on interest rates and risk tolerance. If your loan rate is 6% and investments might earn 10%, investing mathematically wins. But paying off debt is a guaranteed return, while investments fluctuate.
Q: Does it matter when I make extra payments?
A: Yes! Extra payments early in the loan have a much larger impact because they prevent years of compounding interest. A $10,000 lump sum in year 1 saves far more than the same amount in year 20.
Q: What is negative amortization?
A: This occurs when your payment doesn't cover the interest due, so the unpaid interest gets added to your balance. Your balance grows instead of shrinking. Very risky — avoid these loans.
Q: How does refinancing affect amortization?
A: Refinancing starts a new amortization schedule. Even with a lower rate, resetting to 30 years can cost more long-term. Consider refinancing to a shorter term if affordable.
Q: What is an amortization table used for?
A: It shows the complete schedule of payments, helping you see exactly how long payoff takes, how much total interest you'll pay, and how your equity builds over time.
Tips to Minimize Interest
- Shop for the lowest interest rate possible — compare multiple lenders
- Choose the shortest term you can afford
- Make extra principal payments, even small ones
- Round up your payment (e.g., $1,896 → $2,000)
- Make bi-weekly payments (26 half-payments = 13 full payments per year)
- Apply windfalls to principal (bonuses, tax refunds)
- Refinance if rates drop significantly (usually 0.75%+ lower)
- Avoid extending the term when refinancing
This calculator provides estimates based on the inputs you provide. Actual loan terms, rates, and payments may vary. Additional costs like property taxes, insurance (for mortgages), and fees are not included. Consult a lender for exact figures.