What It Means
Amortization is the way an installment loanInstallment loanA loan you receive as one lump sum and repay in a set number of scheduled payments, such as a car loan, mortgage or personal loan. See more gets paid down to zero over its term. Each payment covers the interestInterest rateThe yearly percentage a lender charges for borrowing money, not counting fees; the APR adds certain fees to show a fuller cost. See more charged on what you still owe and puts the rest toward the principal, the amount you borrowed. The Consumer Financial Protection Bureau (CFPB) explains that the payment stays the same, but early on a bigger share goes to interest, and near the end most of it goes to principal. A table listing every payment and that split is called an amortization schedule.
Try It: Slide Through a Loan Month by Month
Set a loan, then slide to any month to see how that payment splits. The payment stays the same; the split moves.
Balance left after this payment:
How People Say It
- "Most of my first payments were just interest."
- "Can you print me the amortization schedule?"
- "We're finally paying more principal than interest."
The Breakdown
Worked example. A $20,000 loan at a fixed 6% over 60 months has a payment of $386.66. Here's how a few of those payments split (amounts rounded to the cent):
| Payment | Interest | Principal | Balance after |
|---|---|---|---|
| Month 1 | $100.00 | $286.66 | $19,713.34 |
| Month 12 | $83.83 | $302.82 | $16,463.94 |
| Month 24 | $65.16 | $321.50 | $12,709.78 |
| Month 36 | $45.33 | $341.33 | $8,724.07 |
| Month 48 | $24.27 | $362.38 | $4,492.53 |
| Month 60 | $1.92 | $384.73 | $0.00 |
What the result means. Interest is charged on the balance still owed, and that balance is biggest at the start. In the first year of this loan, $1,103.81 of the payments goes to interest; in the fifth year, only $147.34 does. Over all 60 months the interest adds up to $3,199.36. The same shape shows up on any fixed-payment loan, from a car loanCar loanAn installment loan used to buy a vehicle, repaid in monthly payments over a set term, with the vehicle as collateral. See more to a 30-year mortgageMortgageA loan used to buy or refinance a home, secured by the home itself and repaid in monthly installments over a set term. See more, though on a long mortgage the early interest share is much larger.
How the split is worked out. Each month, the lender multiplies the balance by the monthly rate (the yearly rate divided by 12) to get that month's interest. Whatever is left of the payment reduces the balance, and the next month starts from the new, lower balance.
Good to Know
The CFPB points out that the way a loan charges interest decides whether paying early saves you money. With simple interestSimple interestInterest figured only on the principal, never on interest already earned, so the same balance at the same rate adds the same amount each period. See more, the interest each month is figured on the balance you actually owe, so paying extra or paying off early cuts the interest; the CFPB says simple interest is generally the better choice if you might pay the loan off early, compared with precomputed interest. The CFPB also notes that a longer term lowers the monthly payment but raises the total interest. Ask your lender which interest method your loan uses and how an extra paymentExtra paymentMoney paid toward a loan on top of the required payment, usually to lower the principal sooner, which cuts the interest and can shorten the loan. See more is applied before you send one.
FAQ
What is an amortization schedule?
A table of every payment on a loan, showing how much goes to interest, how much to principal, and the balance left afterward. You can ask your lender for yours, and the tool above builds a simple version.
Why does so much of my early payment go to interest?
Interest is charged on what you still owe, and you owe the most at the start. As the CFPB explains, the principal comes down slowly at first and faster toward the end of the term.
Does a longer loan term change amortization?
Yes. The payment drops, but the balance comes down more slowly, so more interest builds up along the way. At 6% on $20,000, stretching from 60 to 72 months lowers the payment to $331.46 and raises the total interest from $3,199.36 to $3,864.96.
Do It in Buhata
Budget, Countdown
Enter the loan payment as a repeating monthly expense in Budget, and add the final payment date to Countdown so you can watch the payoff day come closer.
Open BuhataRelated Terms and Categories
- Interest rate
The yearly percentage a lender charges for borrowing money, not counting fees; the APR adds certain fees to show a fuller cost.
- Loan term
How long you have to repay a loan, usually stated in months for a car loan and in years for a mortgage.
- Fixed interest rate
An interest rate that's set when you borrow and stays the same for the life of the loan, so the monthly payment doesn't change.
- Extra payment
Money paid toward a loan on top of the required payment, usually to lower the principal sooner, which cuts the interest and can shorten the loan.
- Installment loan
A loan you receive as one lump sum and repay in a set number of scheduled payments, such as a car loan, mortgage or personal loan.
Sources
Consumer Financial Protection Bureau, "What is amortization and how could it affect my auto loan?"; CFPB, "What's the difference between a simple interest rate and precomputed interest on an auto loan?"
- www.consumerfinance.gov/ask-cfpb/what-is-amortization-and-how-could-it-affect-my-auto-loan-en-771
- www.consumerfinance.gov/ask-cfpb/whats-the-difference-between-a-simple-interest-rate-and-precomputed-interest-on-an-auto-loan-en-841
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