What is Amortization?
Learn how loan amortization works, the difference between amortization schedules, and how payment structure affects your total interest paid.
Amortization is the process of paying off a loan through regular scheduled payments that cover both principal and interest. With each payment, you reduce the loan balance while also paying interest on the remaining amount.
How Amortization Works
In a standard amortizing loan, your monthly payment stays the same throughout the term, but the split between principal and interest changes. Early payments are mostly interest; later payments are mostly principal.
This happens because interest is calculated on the remaining balance. As you pay down principal, less interest accrues, so more of each payment goes toward principal.
Amortization Example
Consider a $100,000 loan at 8% interest over 5 years. Your monthly payment is approximately $2,028. In month one, about $667 goes to interest and $1,361 to principal. By month 60, only $13 goes to interest and $2,015 to principal.
Total Interest Paid
On this $100,000 loan, you would pay approximately $21,660 in total interest over 5 years. Longer terms mean lower payments but more total interest.
Amortization Schedules
Your lender provides an amortization schedule showing each payment breakdown. This document shows:
- Payment number and date
- Total payment amount
- Principal portion
- Interest portion
- Remaining balance after payment
Types of Loan Repayment Structures
Not all loans are fully amortizing:
- Fully amortizing: Regular payments pay off the entire loan by maturity
- Partially amortizing (balloon): Lower payments during the term, with a large final payment
- Interest-only: Pay only interest during an initial period, then begin amortizing
Why Amortization Matters
Understanding amortization helps you see how much you actually pay over the life of a loan. It also shows why making extra principal payments early in the loan term can significantly reduce total interest.
A $100 extra payment in year one saves more than the same payment in year four because you avoid years of interest on that $100.
Ask your lender for an amortization schedule before closing. Review it to understand your payment structure and how much you will pay in total interest over the loan term.
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