In this article:
- What Is Amortization?
- How Does Loan Amortization Work?
- What Is an Amortization Schedule?
An amortizing loan has fixed, periodic payments that are applied to both the principal and interest until the loan is paid in full. At the beginning of your repayment period, more—if not most—of your payment covers the cost of interest. Near the end of your loan, your payment will mostly go toward paying off the remaining principal balance.
What Is Amortization?
Amortization is how lenders are able to charge interest on a loan while keeping payments at a fixed amount throughout the life of the loan. Your monthly payments cover both interest and principal, with the interest payments becoming increasingly smaller over the payment term.
The interest rate you pay is calculated as a percentage of the original amount you borrowed and can vary based on your credit score, credit history, the amount borrowed and other factors.
Types of Amortizing Loans
Most installment loans are amortizing loans. The most common types include:
- Auto loans
- Personal loans
- Mortgage loans
- Home equity loans
- Student loans
Common types of unamortized or non-amortizing loans might include:
- Credit cards
- Loans that require a balloon payment
- Home equity lines of credit (HELOCs)
- Interest-only loans
How Does Loan Amortization Work?
With loan amortization, the monthly payment remains the same, but you pay more in interest during the early years of a loan. Later on, it switches to paying more in principal.
Amortizing loans can be easier to manage than non-amortizing loans or other types of debt because you have a clear idea of when you'll pay off the loan. If the amortizing loan has a fixed interest rate, you'll also know the monthly payment amount over the life of the loan.
For example, let's say you get a mortgage in the amount of $250,000 in July 2022. The loan term is 30 years, and your interest rate is 6.5%. Total interest over the life of the loan will be $318,861, with a total loan payment of $568,861 over 30 years.
In the first year you make payments, $16,167 goes to interest and just $2,794 goes to the loan's principal. As you continue to make your payments, the interest you pay will decrease, and your principal portion will increase. By the final year of payments, just $651 will go toward the interest, with the remaining $18,310 of your loan's payments going toward paying off the principal.
What Is an Amortization Schedule?
A loan's amortization schedule shows how much of every monthly loan payment you make goes toward principal and interest until the loan is paid in full.
On fixed loans, the amount of principal you pay each month remains the same over the life of the loan. Early in the loan amortization schedule, the bulk of each monthly payment goes to interest. Later on, the majority of each payment goes to the principal.
A typical amortization schedule includes:
- Loan details: The total loan amount, loan term and interest rate.
- Payments: The amount of your payment and how often you'll make payments. Monthly payments are the most common.
- Total loan payments: The total number of payments you're expected to make during the loan term.
- Loan principal payment: How much of your monthly payment goes to paying off the loan principal. This number will increase as you pay off your loan.
- Interest: How much of each monthly payment goes to paying off the interest portion of your loan. This number will decrease over the life of the loan.
- Outstanding balance: Your outstanding loan balance after each scheduled payment.
Some amortization tables will also include a column for extra payments if you decide to make a payment (or two) over and above your minimum monthly payment amount.
Tipping the Scale
Amortizing loans offer a clear picture of the total principal and interest you'll pay over the life of your loan. At the beginning of an amortized loan's term, more of your payment goes to paying off the interest. Later on, your fixed monthly payment will almost entirely go toward paying off the principal loan amount until the balance is paid in full. If you're shopping for an amortizing loan, but are not sure you'll qualify, get an Experian credit report and view your credit score for free.
