Amortization is the process of spreading out a loan into a series of fixed payments over time. Each payment covers both interest and principal, with the proportion shifting over the life of the loan. In the early years, a larger portion of each payment goes toward interest, while in later years, more goes toward principal. An amortization schedule shows exactly how each payment is split and how the loan balance decreases over time. The term also applies to the gradual write-off of intangible assets in accounting.
Amortization
Definition
Amortization is the process of spreading out a loan into a series of fixed payments over time. Each payment covers both interest and principal, with the proportion shifting over the life of the loan. In the early years, a larger portion of each payment goes toward interest, while in later years, more goes toward principal. An amortization schedule shows exactly how each payment is split and how the loan balance decreases over time. The term also applies to the gradual write-off of intangible assets in accounting.
Example
On a $300,000 30-year mortgage at 6%, the monthly payment is $1,799. In Month 1, $1,500 goes to interest and $299 to principal. By Month 180 (halfway), $1,028 goes to interest and $771 to principal. By Month 360, only $9 goes to interest and $1,790 to principal.
Key Points
- 1Early payments are mostly interest; later payments are mostly principal
- 2Extra principal payments can dramatically reduce total interest and loan term
- 3Amortization schedules are available from lenders and online calculators
- 4Shorter loan terms (15 vs 30 years) have higher payments but much less total interest