Amortization

The process of spreading out a loan into a series of fixed payments over time.

Finance2 min read

Definition

Amortization is the process of spreading out a loan into a series of fixed payments over time. In an amortized loan, your monthly payment remains the same for the entire life of the loan, but the mathematical breakdown of where that money goes changes every single month.

Why It Matters

Understanding amortization is crucial if you have a mortgage or an auto loan.

Because interest is calculated based on your remaining loan balance, your earliest loan payments will consist almost entirely of interest, with very little money going toward paying down the principal. As the years go on and your principal balance decreases, less interest is generated, meaning more of your fixed monthly payment starts going toward the principal.

This heavily front-loaded interest schedule is why paying extra money toward your principal in the early years of a loan can save you tens of thousands of dollars in total interest.

Practical Example

Consider a $300,000, 30-year mortgage at a 6% interest rate. Your fixed monthly payment is $1,798.65.

  • Month 1: $1,500 goes to interest. Only $298.65 goes to principal.
  • Year 15: The split is roughly even: $900 to interest, $898 to principal.
  • Final Month: Only $8.95 goes to interest. $1,789.70 goes to principal.

You can generate a full amortization schedule for your own home loan using our Mortgage Calculator.

Frequently Asked Questions

What is an amortization schedule?

A complete table of periodic loan payments showing the amount of principal and the amount of interest that comprise each payment until the loan is paid off.