How Amortization Works

What is Amortization?

Bar charts build with multi colored rods
Sometimes it's good when the chart goes down. Erik Dreyer / Getty Images

Amortization happens when you pay off a debt over time with regular, equal payments. With each payment (generally monthly payments), a portion of the money goes towards:

  1. The interest costs (what your lender gets paid for the loan), and
  2. Reducing your loan balance (also known as paying off the loan principal)

At the beginning of the loan, your interest costs are at their highest. Especially with long-term loans, the majority of each periodic payment is an interest expense, and you only pay off a small piece of the balance.

As time goes on, more and more of each payment goes towards your principal (and you pay less in interest each month).

Amortized loans are designed so that after a certain amount of time your last loan payment will completely pay off the loan balance. For example, after exactly 30 years (or 360 monthly payments) you’ll pay off a 30-year mortgage.

Amortization in Action

Sometimes it’s helpful to see the numbers instead of reading about the process. Scroll to the bottom of this page to see an example of an auto loan being amortized. The table below is known as an amortization table (or amortization schedule), and these tables help you understand how each payment affects the loan, how much you pay in interest, and how much you owe on the loan at any given time.

Sample Amortization Table

The table below shows the amortization schedule for the beginning and end of an auto loan. This is a $20,000 five-year loan charging 5% interest (with monthly payments).

To see the full schedule, use a loan amortization calculator.

Amortization Table
MonthBalance (Start)PaymentPrincipalInterestBalance (End)
1$ 20,000.00$ 377.42$ 294.09$ 83.33$ 19,705.91
2$ 19,705.91$ 377.42$ 295.32$ 82.11$ 19,410.59
3$ 19,410.59$ 377.42$ 296.55$ 80.88$ 19,114.04
4$ 19,114.04$ 377.42$ 297.78$ 79.64$ 18,816.26
. . . .. . . .. . . .. . . .. . . .. . . .
57$ 1,494.10$ 377.42$ 371.20$ 6.23$ 1,122.90
58$ 1,122.90$ 377.42$ 372.75$ 4.68$ 750.16
59$ 750.16$ 377.42$ 374.30$ 3.13$ 375.86
60$ 375.86$ 377.42$ 374.29$ 1.57$ 0

Looking at amortization is extremely helpful if you want to understand how borrowing works. You can clearly see how much you really pay in interest – instead of focusing on a monthly payment. You can also decide which loan to choose when lenders offer different terms (how much could you save with a lower interest rate?). Finally, you can even calculate how much you’d save by paying off debt early – you’ll get to skip all of the remaining interest charges on most loans.

To visualize amortization, picture a chart (your loan balance is the X axis and time is the Y axis) with a line going down and to the right. With shorter-term loans, the line is more or less straight. With longer-term loans, the line gets steeper as time goes on.

How to Amortize Loans: Calculations

You can build your own amortization tables like the one above, use an online calculator to do the work, or use spreadsheets to create and analyze loans (you can often copy and paste the output of the online calculator into a spreadsheet if that’s any easier).

With an amortizing loan, figuring out the payment is just math. The payment is based on the amount of the loan, the interest rate, and how many years the loan lasts. Those three ingredients work together to affect how much you pay each month and how much total interest you’ll pay. Lowering the interest rate can lower your payment, and it helps you save money. Stretching out the loan over a longer period of time will also lower your payment, but you’ll end up paying more in interest over the life of the loan.

To amortize a loan, use the table above as an example:

  1. Note your starting loan balance: $20,000
  2. Figure out the payment (calculation shown on this page): $377.42
  3. Figure out the interest charge for each period – usually monthly (calculation shown on this page): $83.33 in the first month
  4. Subtract the interest charge from your payment – the remainder is the amount of principal you'll pay that month: $294.09 in the first month
  5. Reduce the loan balance by the amount of principal you've paid: you owe $19,705.91 after your first payment
  6. Start over with the following month: $19,705.91 is the loan balance in the second month

What is an Amortized Loan? What Doesn’t Amortize?

It might help to review common examples of amortized loans. Any installment loan is a loan that amortizes: you pay the balance down to zero over time with level payments.

  • Auto loans are often five-year (or shorter) amortized loans that you pay down with a fixed monthly payment. In fact, some people – including buyers and auto dealers – think of buying an auto in terms of the monthly payment alone. Longer loans are available, but you risk being upside-down on your loan if you stretch things out to get a lower payment (plus you’ll spend more on interest).
  • Home loans are traditionally 15-year or 30-year fixed rate mortgages. Most people don’t keep a loan for that long – they sell the home or refinance the loan at some point – but these loans work as if you were going to keep them for the entire term.
  • Personal loans that you get from a bank, credit union, or online lender are generally amortized loans as well. They often have three-year terms, fixed interest rates, and fixed monthly payments. These loans are often used for small projects or debt consolidation.

Loans that are not Amortized

  • Credit cards are not amortizing loans. You can borrow again and again on the same card, and you get to choose how much you’ll repay each month (at least the minimum – but more is better). These types of loans are also known as revolving debt.
  • Interest only loans don’t amortize either – at least not at the beginning. During the “interest only period” you’ll only pay down the principal if you make additional payments above and beyond the interest cost.
  • Balloon loans require you to make a large principal payment at the end of the loan’s life. During the early years of the loan you’ll make small payments, but the entire loan comes due someday. In most cases, you’ll refinance at that point (unless you have a large chunk of change on hand).

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