How Amortization Works
An amortized loan has fixed periodic payments that cover both principal and interest. In the early months, most of each payment goes toward interest. Over time, the interest portion decreases and more goes toward paying down the principal.
Formula: M = P × [r(1+r)n] / [(1+r)n − 1]
- M = monthly payment
- P = principal (loan amount)
- r = monthly interest rate (annual rate / 12)
- n = total number of payments
Effect of Extra Payments
Making extra payments reduces the outstanding principal faster, which means less interest accrues each month. Even small extra payments can significantly shorten a loan term. For example, adding $100/month to a $200,000 mortgage at 6% over 30 years saves over $50,000 in interest and pays off the loan 5+ years early.
Amortization Schedule
The schedule breaks down every payment into principal and interest components. Two views are available:
- Annual schedule: Shows yearly totals for interest paid, principal paid, and ending balance — matches the format used by banks and financial advisors.
- Monthly schedule: Shows each individual payment with its exact principal, interest, and remaining balance.
Common Amortized Loans
- Mortgages: Typically 15 or 30 years at fixed rates
- Auto loans: Usually 3–7 years
- Personal loans: 1–7 years
- Student loans: 10–25 years for federal loans
Non-amortized loans like credit cards and interest-only mortgages work differently — the balance doesn't automatically decrease with each payment.