How Loan Amortization Works (and What Extra Payments Save)

Five years into a 30-year mortgage, many people check their statement and find they've paid off surprisingly little of the loan. Nothing is wrong. That's how amortization works: with a fixed payment, the early years go mostly to interest and the later years mostly to principal.

Here's how the payment is calculated, why the split shifts over time, and what extra payments really save, using one worked example from start to finish.

Note: the figures in this article are estimates for illustration, not financial advice. Your lender's numbers can differ because of fees, escrow, rounding and loan terms. Check your loan documents or ask your lender before making decisions.

What amortization means

An amortizing loan is paid off in regular installments that each cover the interest due for that period plus part of the principal. The Consumer Financial Protection Bureau describes it this way: "In an amortizing loan, a percentage of your monthly payment is applied to the principal and to the interest," and the chart that shows the split for each payment "is called an amortization schedule" (CFPB).

Mortgages, car loans and most personal loans in the U.S. work like this. The payment stays the same every month for a fixed-rate loan. Only the split changes.

The example loan

Throughout this article: a $300,000 loan at 6.5% fixed annual interest over 30 years (360 monthly payments). All results below come from our Loan Calculator, and they cover principal and interest only, not property taxes or insurance.

How the monthly payment is calculated

The standard formula for a fixed payment is:

M = P × r ÷ (1 − (1 + r)^−n)

P = loan amount
r = monthly interest rate (annual rate ÷ 12)
n = number of payments

For the example:

• r = 0.065 ÷ 12 = 0.00541667
• (1 + r)³⁶⁰ = 6.9918
• M = 300,000 × 0.00541667 × 6.9918 ÷ (6.9918 − 1) = $1,896.20

That payment is set so that, after exactly 360 payments, the balance reaches zero.

How each payment is split

Every month, interest is charged on the balance that's still owed:

interest   = balance × r
principal  = payment − interest
new balance = balance − principal

The first two payments:

In the first month, $1,625 of the $1,896.20 payment is interest: 6.5% a year on $300,000 is $19,500, or $1,625 a month. Only $271.20 reduces the loan. Because the balance falls slightly, the next month's interest is a little lower and the principal a little higher, and so on for 30 years. The last payment is a few dollars larger because it absorbs the rounding from paying whole cents each month.

Why early payments are mostly interest

Interest is calculated on the remaining balance, and in the early years the balance is close to the full loan amount. As the CFPB puts it, "at the beginning of your loan term, more of your payment is generally applied toward the interest rather than the principal."

The numbers for the example loan make this concrete:

• After 5 years (60 payments), you've paid $94,605.26 in interest but only $19,166.74 in principal. You still owe $280,833.26.
• Principal first becomes larger than interest at payment 233, more than 19 years in.
• The balance drops below half the original loan after payment 257, about 21 years in.
• Over the full term, you pay $382,636.71 in interest, more than the amount borrowed. Total paid: $682,636.71.

This is also why selling or refinancing in the first few years leaves you with most of the original balance still to pay off.

What extra payments really save

Any extra amount you pay toward principal reduces the balance right away, so every later payment carries less interest. And because the regular payment doesn't change, more of each later payment goes to principal. The effect compounds.

Adding $200 a month to the example loan:

The loan is paid off 83 payments early, almost 7 years sooner. The Loan Calculator shows this comparison automatically when you enter an extra amount per payment.

Extra payments help most early in the loan, when the balance is highest. The same $200 a month started in year 20 saves far less, because there's much less interest left to avoid.

Before you pay extra

• Make sure it goes to principal. Ask your servicer how to mark extra payments as principal-only. Otherwise some servicers hold the money or apply it to the next scheduled payment.
• Check for a prepayment penalty. The CFPB explains that a prepayment penalty is "a fee that some lenders charge if you pay off all or part of your mortgage early." Not all loans have one, and they usually apply to paying off the whole balance within the first few years, but read your loan documents or ask your lender.
• Your monthly payment won't drop. On a standard fixed-rate loan, extra payments shorten the loan; they don't lower the required payment unless the lender re-amortizes ("recasts") the loan.
• Compare with other uses of the money. Paying extra earns you the loan's interest rate, risk-free. Whether that beats an emergency fund, retirement contributions or paying off higher-interest debt depends on your situation.

How the rate and the term change the picture

Small differences in rate add up over 30 years. The same $300,000 loan at 6.25% instead of 6.5% has a payment of $1,847.15, which is $49.05 a month less, and $17,660.91 less total interest. That quarter-point gap is a 0.25 percentage point difference, not a 0.25% difference, which is a distinction covered in Percent Change vs Percentage Points.

A shorter term changes even more. Over 15 years at the same 6.5%, the payment rises to $2,613.32, but total interest falls to $170,398.28, less than half of the 30-year total. In practice, 15-year loans often come with lower rates as well, which widens the gap.

Reading your own amortization schedule

To see your own numbers, enter your loan amount, rate and term in the Loan Calculator, set the date of your first payment, and switch the schedule between monthly rows and yearly totals. You can download the schedule as a CSV for a spreadsheet. If your loan is already running, compare the calculator's balance for your current payment number with your latest statement. Small differences are normal, because lenders count days and round differently.

FAQ

Why does my balance go down so slowly at first?

Because interest is charged on the full outstanding balance, which is highest at the start. In the example, only $271.20 of the first $1,896.20 payment reduces the loan.

Is it better to pay extra every month or one lump sum a year?

Money paid earlier saves slightly more interest, because the balance drops sooner. So $2,400 at the start of the year beats $200 a month, which beats $2,400 at the end of the year. The differences are small compared with the effect of paying extra at all, so pick whatever you'll stick with.

Does paying every two weeks save money?

Paying half the monthly amount every two weeks adds up to 26 half-payments, the same as 13 monthly payments a year. The savings come from that extra payment, so you can get a similar effect by adding one-twelfth of a payment each month.

Are these numbers what my lender will charge?

They're estimates. Actual payments can include escrow for taxes and insurance, and interest calculation and rounding vary by lender. Use your loan documents for exact figures.

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