How Amortization Works

Paying down a balance over time

Calculator and paper sheets with data
••• Photography taken by Mario Gutiérrez. / Getty Images

Amortization is the process of spreading out a loan into a series of fixed payments over time. You'll be paying off the loan's interest and principal in different amounts each month, although your total payment remains equal each period. This most commonly happens with monthly loan payments, but amortization is an accounting term that can apply to other types of balances, such as allocating certain costs over the lifetime of an intangible asset.

With loans, including home loans and auto loans, while each monthly payment remains the same, the payment is made up of parts that change over time. A portion of each payment goes towards:

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

At the beginning of the loan, 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 portion of the balance. In other words, you don’t make much progress on the debt's principal repayment during the early years.

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

Amortized loans are designed to completely pay off the loan balance over a set amount of time. Your last loan payment will pay off the final amount remaining on your debt. For example, after exactly 30 years (or 360 monthly payments) you’ll pay off a 30-year mortgage.

Your monthly loan payments don’t change; the math simply works out the ratios of debt and principal payments each month until the total debt is eliminated.

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 or create your own table, use a loan amortization calculator.

Month Balance (Start) Payment Principal Interest Balance (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
Amortization Table

Looking at amortization is extremely helpful if you want to understand how borrowing works.

The true cost of borrowing: With a detailed picture of your loan’s components, you can clearly see how much you really pay in interest, instead of focusing on a monthly payment.

Consumers often make decisions based on an “affordable” monthly payment, but interest costs are a better way to measure the real cost of what you buy. Sometimes a lower monthly payment actually means you’ll pay more in interest, if you stretch out the repayment time, for example.

Decision making: You can also decide which loan to choose when lenders offer different terms (how much could you save with a lower interest rate?). 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 with your loan balance as the vertical X-axis and time as the horizontal 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

There are several ways to get amortization tables (like the one above) for your loans:

  1. Build your own table by hand.
  2. Use an online calculator, which will create the table for you.
  3. Use spreadsheets to create amortization schedules and help you analyze loans.

Online calculators and spreadsheets are often easiest to work with, and you can often copy and paste the output of an online calculator into a spreadsheet if you prefer not to build the whole model from scratch.

The monthly payment: 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, and complete the following steps:

  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): $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'll 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

Types of Amortizing Loans

There are numerous types of loans available, and they don’t all work the same way. Any installment loan is amortized and 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, meaning your loan exceeds your car's resale value if you stretch things out too long 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 Don't Get Amortized

  • Credit cards are not amortizing loans. You can borrow repeatedly on the same card, and you get to choose how much you’ll repay each month (as long as you meet the minimum payment – 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 optional 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 eventually. In most cases, you’ll likely refinance the balloon payment, unless you have a large sum of money on hand.

Article Sources

  1. Citi. "Amortization and Paying Off Your Mortgage." Accessed March 23, 2020.

  2. Colorado State University Extension. "Long-Term Loan Repayment Methods," Page 1. Accessed March 23, 2020.

  3. Consumer Financial Protection Bureau. "What Is Negative Amortization?" Accessed March 23, 2020.

  4. Consumer Financial Protection Bureau. "Can I Prepay My Loan at Any Time Without Penalty?" Accessed March 23, 2020.

  5. Prosper. "Prosper Personal Loan Types." Accessed March 23, 2020.

  6. Discover. "Installment Credit vs. Revolving Debt: Which Should You Pay Down First?" Accessed March 23, 2020.

  7. Consumer Financial Protection Bureau. "What Is an Interest-Only Loan?" Accessed March 23, 2020.

  8. Consumer Financial Protection Bureau. "What Is a Balloon Payment? When is One Allowed?" Accessed March 23, 2020.