How does loan amortization work?

Amortization is how a fixed loan payment gets split between interest and principal each month. Early payments are mostly interest because the balance is large, and each month a bit more goes to principal until the loan hits zero on schedule.

The payment is fixed, the split is not

On a fixed-rate amortizing loan you pay the same amount each month. What changes is how much of it goes to interest and how much goes to principal.

Interest comes first every month

The lender takes the month's interest out of your payment first. Whatever is left lowers your balance, so next month's interest is a little smaller.

Longer terms mean more interest

Spreading a loan over more months lowers the payment but keeps the balance higher for longer, so you pay more interest over the life of the loan.

Credit cards are not amortizing loans

A credit card has no fixed payoff date or set payment. The minimum payment changes with your balance, which is why paying only the minimum can drag on for years.

How each payment gets split

Start with the balance and the APR. Divide the APR by 12 to get the monthly rate, then multiply by the balance. That is this month's interest. Subtract it from your payment, and the rest is principal.

For Leo's $20,000 loan at 7%, the monthly rate is 7% ÷ 12, about 0.583%. Month 1 interest is $20,000 × 7% ÷ 12 = $116.67. His payment is $396.02, so $396.02 − $116.67 = $279.35 lowers the balance to $19,720.65. Month 2 starts from that smaller number.

How the payment amount is set

The lender picks a payment that brings the balance to exactly zero on the last month, given the rate and the term. The math uses a standard formula, and any loan calculator, including ours, runs it for you.

You don't need the formula to use it well. Just know that three inputs set the payment: how much you borrow, the rate and the number of months. Change any one and the payment and total interest change.

Reading an amortization schedule

An amortization schedule is a table with one row per payment. Each row shows the payment number, the interest, the principal and the balance left. Scan down the interest column and it shrinks, while the principal column grows.

The schedule also shows why the balance falls slowly at first and faster near the end. In Leo's first year, $3,462 of his payments goes to principal and $1,290 to interest. In his fifth year, $4,577 goes to principal and only $175 to interest.

Why mortgages feel so slow

The same thing happens on a mortgage, only bigger and longer. On a $300,000 30-year mortgage at 6.5%, the payment for principal and interest is about $1,896. In month 1, $1,625 of that, about 86%, is interest.

After 15 years of payments, that borrower still owes about $217,677. Over the full 30 years, the interest adds up to about $382,633, more than the amount borrowed. A shorter term or extra principal payments change that a lot.

What extra payments do

Any extra money you send toward principal comes straight off the balance. Every later month's interest is then charged on a smaller number, so the savings repeat for the rest of the loan.

If Leo adds $50 a month, paying $446.02 instead of $396.02, he finishes in 53 months instead of 60 and pays about $3,253 in interest instead of $3,761. A single extra payment works too, and the earlier it comes, the more it saves.