Loan Amortization Explained
Amortization is the process of paying off debt through regular payments over time. Each payment covers interest on remaining balance plus principal reduction. Early payments are mostly interest, later payments mostly principal. A $200,000 loan at 6% for 30 years requires $1,199 monthly - first payment is $1,000 interest and only $199 principal.
Amortization schedules show payment breakdown month by month. As principal decreases, interest portion shrinks and principal portion grows. After 15 years on the example above, you've paid $215,820 but only reduced principal by $48,000 - the rest went to interest. This is why extra principal payments early save substantial interest.
Understanding amortization helps you make informed decisions about loans. Making one extra payment annually can shave years off your mortgage and save tens of thousands in interest. Even small additional principal payments accumulate significant savings over time by reducing future interest calculations.
Quick Tips
- Always compare APR, not just interest rates
- Use the Rule of 72 to estimate doubling time
- Extra payments dramatically reduce total interest
Frequently Asked Questions
Because interest is calculated on remaining balance. Early in the loan, balance is highest, so interest is highest. As you pay down principal, interest decreases and more of each payment goes toward principal.
Significant amounts. Adding $100/month to a $200,000 30-year mortgage at 6% saves $62,000 in interest and pays off loan 6 years early. Extra payments early in loan term save the most.
Depends on loan rate vs investment returns. If mortgage is 6% and you can earn 8% investing, invest. If loan is 8% and investments return 6%, pay extra toward loan. Consider risk tolerance too.