What Is Loan Amortization?
Loan amortization is the process of paying off a debt over time through regular payments. Each payment covers both the interest accrued and a portion of the principal balance. In the early years of a loan, most of your payment goes toward interest. As the balance decreases, more of each payment goes toward the principal.
How the Monthly Payment Is Calculated
M = P × [r(1+r)n] / [(1+r)n - 1] Where:
- M = Monthly payment
- P = Principal (loan amount)
- r = Monthly interest rate (annual rate / 12)
- n = Total number of payments (years × 12)
The Impact of Extra Payments
Making extra payments toward your loan principal can dramatically reduce the total interest you pay and shorten the loan term. Even an extra $100 per month on a 30-year mortgage can save tens of thousands of dollars and cut years off the loan.
Use the "Extra Monthly Payment" field above to see exactly how much you could save.
Types of Amortizing Loans
- Fixed-rate mortgages: The most common amortizing loan, with a consistent interest rate and payment throughout the loan term.
- Auto loans: Typically 3-7 year terms with fixed monthly payments.
- Personal loans: Usually 2-5 year terms, fully amortizing.
- Student loans: Federal student loans use standard amortization over 10-25 years.
Frequently Asked Questions
Why does most of my payment go to interest at first?
Interest is calculated on the outstanding balance. When your balance is highest (at the beginning), the interest portion is largest. As you pay down the principal, less interest accrues each month, so more of your payment goes toward principal.
Should I make extra payments?
If your loan allows it without penalties, extra payments can save significant money over the life of the loan. However, first ensure you have an emergency fund and have paid off higher-interest debt.