Glossary · Definition
Loan amortization
Loan amortization is the schedule by which a fixed-payment loan is paid off — each payment covers the month’s interest plus enough principal to retire the loan at the end of the term. The schedule front-loads interest, which is why early prepayment dramatically accelerates payoff.
Definition
Loan amortization is the schedule by which a fixed-payment loan is paid off — each payment covers the month’s interest plus enough principal to retire the loan at the end of the term. The schedule front-loads interest, which is why early prepayment dramatically accelerates payoff.
What it means
An amortized loan splits each fixed monthly payment into two parts: interest accrued over the past month (calculated on the remaining balance) and principal (everything else). Early in the loan, principal balance is large, so interest is large and principal portion is small. As you pay down, the interest portion shrinks and principal grows. By the end, almost every dollar retires principal. The amortization schedule is just the month-by-month breakdown — most loan documents include one. Spreadsheet trick: <code>=PMT(rate/12, term*12, -principal)</code> for monthly payment, then build the schedule in a table.
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Formula
M = P × [r(1+r)^n] / [(1+r)^n - 1]
Why it matters
Understanding amortization changes how you think about loans. The advertised rate is the same throughout, but the dollar cost of interest is wildly higher in early years. A $5,000 extra principal payment in year 1 of a 30-year mortgage saves about $30,000 in interest. The same $5,000 in year 25 saves about $1,000. This is also why refinancing into a fresh 30-year mortgage at a lower rate doesn’t always save money — you’re restarting the front-loaded schedule, which can wipe out the rate savings.
Example
30-year, $320,000 loan at 6.5%: monthly P&I $2,022. First month: $1,733 interest + $289 principal. Year 15 month: ~$1,000 interest + $1,000 principal. Last month: ~$11 interest + $2,011 principal. Total interest paid over 30 years: $408,000.
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Frequently asked questions
Are all loans amortized?
Most consumer loans (mortgage, auto, personal, student) are. Credit cards, lines of credit, and interest-only loans use different mechanisms. Bonds typically pay interest periodically with principal at maturity, not amortized.
How do I see my loan’s amortization schedule?
Most lender portals show it. You can also build one in Excel using the PMT() and IPMT()/PPMT() functions, or use a free amortization-schedule generator.
What if I make extra payments?
They reduce principal directly, which reduces all future interest. Specify ‘apply to principal’ on any extra payment so it doesn’t get credited as a future scheduled payment.
Related terms
- DefinitionAmortizationAmortization is the process of paying off a loan with equal periodic payments that are split between interest and principal. In the early months, most of your payment goes to interest; as the balance shrinks, more goes to principal.
- DefinitionAPRAPR (Annual Percentage Rate) is the total yearly cost of borrowing money, expressed as a percentage — including the interest rate plus most fees. It's the number you should compare between loans, not the 'interest rate'.
- DefinitionMortgage interestMortgage interest is the cost of borrowing money to buy a home, calculated monthly on your remaining principal balance. Because each payment retires some principal, interest paid declines over time — and that’s why early prepayment saves dramatically more than late prepayment.