How loan amortization works
With an amortizing loan, such as a typical fixed-rate mortgage, you make the same payment every month, but what that payment does keeps changing. Early on, most of it goes to interest. By the end, almost all of it goes to principal.
If you have ever looked at your mortgage statement and been surprised at how slowly the balance falls, it is not a mistake or a trick. It is simply how the math works.
Why it happens
Each month, you pay interest only on what you still owe. At the beginning you owe a lot, so the interest is high. Whatever is left of the payment reduces the balance, so next month’s interest is slightly lower. Since the payment does not change, a little more goes to principal each month.
A full example
A $300,000 mortgage at 6.5% over 30 years has a monthly payment of $1,896.20. The monthly interest rate is 6.5% ÷ 12, or about 0.5417%.
Month 1: $300,000 × 0.5417% = $1,625 in interest. The remaining $271.20 reduces your balance to $299,728.80.
Here is how the split changes over the life of the loan:
| Month | Interest | Principal | Remaining balance |
|---|---|---|---|
| 1 | $1,625.00 | $271.20 | $299,728.80 |
| 12 | $1,608.40 | $287.81 | $296,646.82 |
| 120 (year 10) | $1,380.41 | $515.80 | $254,328.38 |
| 180 (year 15) | $1,182.95 | $713.25 | $217,677.42 |
| 240 (year 20) | $909.90 | $986.30 | $166,995.85 |
| 360 (year 30) | $10.22 | $1,885.99 | $0 |
After 15 years, half the term, you have paid off only about $82,300, or 27% of the loan. In total, you repay $682,633, and $382,633 of that is interest. More than half of all you pay goes to interest.
If you want to check the payment yourself, here is the formula:
Payment = principal × i ÷ (1 − (1 + i)^−n)
Here, i is the monthly rate as a decimal and n is the number of payments. You can also see the full yearly breakdown in the loan calculator.
Term matters a lot
The same loan over 15 years has a payment of $2,613.32, which is $717.12 more a month. Total interest falls from $382,633 to about $170,398, a saving of more than $212,000.
A longer term makes each month easier, but it costs a lot more. A shorter term saves a lot, but gives you less breathing room. The right balance depends on how much you can handle when things go wrong.
What extra payments can do
An extra payment goes straight to principal, which reduces the balance that future interest is based on. That is why the earlier you pay extra, the more you save.
Adding $200 a month to the example above:
| Monthly payment | Paid off in | Total interest | |
|---|---|---|---|
| Standard | $1,896.20 | 30 years | $382,633 |
| With $200 extra | $2,096.20 | About 23 years | $279,185 |
You would save over $103,000 and finish about seven years sooner.
Before you do this, check three things:
- Prepayment penalties. Most standard mortgages today have none, but check your loan documents.
- Your safety net. Money paid into a mortgage is hard to get back out. Build an emergency fund first.
- Other debts. If you carry a credit card at 22%, that comes before a mortgage at 6.5%, as we explain in pay off debt or invest.
Tell your lender to apply extra payments to principal, then confirm on your next statement that they did.
Recasting vs. shortening
Extra payments normally shorten the loan and leave your required payment the same. Some lenders also offer a recast: after a large lump-sum payment, they recalculate your payment on the lower balance for the remaining term, usually for a small fee. A recast gives you more monthly breathing room, but it saves less interest than simply keeping the same payment.
What changes with an adjustable rate
On an adjustable-rate mortgage, the lender recalculates your payment at each adjustment, using the new rate, the remaining balance and the remaining term. If the rate rises, the interest portion goes up, and so does your payment.
Not all loans work this way
Credit cards do not amortize on a fixed schedule: your balance can linger for years if you pay only the minimum. Interest-only loans do not reduce principal at all during the interest-only period. And biweekly payment plans simply make the equivalent of one extra monthly payment a year; you can do the same yourself without paying a service fee.
To compare offers, look at the total cost and the difference between the APR and the interest rate.