Amortization

How loan amortization works

In an amortizing loan, every payment is the same total amount, but the split between interest and principal changes over time. Interest is calculated each period on the remaining balance, so when the balance is large (early in the loan) most of the payment goes to interest; as the balance shrinks (later in the loan) the same payment chips away faster at principal.

A 30-year, $400,000 mortgage at 7% has a fixed monthly payment of about $2,661. In month one, roughly $2,333 of that goes to interest and only $328 to principal. By year 25, the split has flipped — most of the payment goes to principal. Total interest paid over the life of the loan exceeds $558,000, more than the loan amount itself.

The amortization schedule

Lenders provide an amortization schedule showing the period-by-period breakdown: opening balance, payment, interest portion, principal portion, ending balance. The schedule is what makes "extra payments toward principal" so powerful — every dollar of extra principal early in the loan eliminates years of compounding interest at the end.

A $200/month extra principal payment on the example mortgage shortens the loan by about seven years and saves over $130,000 in interest, depending on rate and timing.

Bullet loans vs. amortizing loans

Not all loans amortize. A "bullet" or "balloon" loan pays only interest along the way and returns the entire principal at maturity. Most corporate bonds work this way: semi-annual coupons followed by a single principal repayment. Some commercial mortgages amortize over a long schedule but balloon at year 5 or 10, requiring a refinance.

Amortization in accounting

Accountants use the same word for a different concept: spreading the cost of an intangible asset (patents, copyrights, customer lists, goodwill in some cases) over its useful life as a non-cash expense. The mechanic is identical to depreciation, which applies to tangible assets. Both reduce reported earnings without affecting cash flow, which is why investors often look at EBITDA — earnings before depreciation and amortization — to see operating performance more clearly.