How Loan Amortization Works (And Why It Matters)
If you've ever looked at a loan statement and wondered why barely any principal is coming off your balance, the answer is amortization. Understanding it helps you make smarter borrowing decisions.
What Is Amortization?
Amortization is the process of paying off a loan through scheduled, equal payments over time. Each payment covers both interest and principal — but the split between them changes dramatically over the life of the loan.
Why You Pay More Interest Early
Interest is calculated on your remaining balance. Early in the loan, your balance is highest, so interest takes up most of the payment. As principal decreases, more of each payment goes to principal.
On a $300,000 mortgage at 6.5% over 30 years, your first payment of ~$1,896 is split roughly $1,625 interest / $271 principal. By year 25, it flips to mostly principal.
Sample Amortization Schedule
| Payment # | Payment | Interest | Principal | Balance |
|---|---|---|---|---|
| 1 | $1,896 | $1,625 | $271 | $299,729 |
| 60 | $1,896 | $1,524 | $372 | $280,142 |
| 180 | $1,896 | $1,247 | $649 | $229,543 |
| 300 | $1,896 | $698 | $1,198 | $127,551 |
| 360 | $1,896 | $10 | $1,886 | $0 |
Why This Matters Practically
- Extra early payments are extremely powerful — they reduce principal which reduces all future interest
- Refinancing late in the loan is often not worth it — you've already paid most of the interest
- Short-term loans aren't just shorter — more principal is paid each month from day one
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