How Loan Amortization Works

What amortization means

An amortizing loan is repaid with equal monthly payments. Each payment first covers the interest that built up since the last one, and whatever is left reduces the balance. Because the balance shrinks over time, the interest part gets smaller and the principal part gets larger with every payment.

The monthly payment

The payment is found with the standard annuity formula M = P × r / (1 − (1 + r)^−n), where:

• P is the amount borrowed
• r is the monthly interest rate (the annual rate divided by 12)
• n is the number of monthly payments

For 200,000 at 6% over 30 years, r is 0.005 and n is 360, which gives a payment of about 1,199.10.

One payment, step by step

1. Interest for the month = current balance × monthly rate. In month one that is 200,000 × 0.005 = 1,000.00.
2. Principal repaid = payment − interest, so 1,199.10 − 1,000.00 = 199.10.
3. New balance = old balance − principal, which leaves 199,800.90.

Repeat this 360 times and the balance reaches zero with the last payment.

Why early payments are mostly interest

Interest is charged on what you still owe. At the start you owe the most, so most of the payment goes to interest. In the example above, it takes more than 18 years before the principal share of a payment is larger than the interest share.

How extra payments help

Any extra amount you pay goes straight to principal. That lowers the balance the next month's interest is calculated on, so every later payment repays a little more principal. Even small regular extra payments can shorten a long loan by years and cut the total interest noticeably. Check first whether your lender charges a prepayment fee.

Try it yourself

The calculators below build the full schedule for you, so you can see exactly how much interest and principal each year contains.