House & Home Calculators

How Amortization Works on Your Home Loan

Amortization describes a method of paying off a loan in fixed, equal monthly payments. With amortization, you know exactly when you’ll pay off a loan, and you know exactly how much you’ll owe every month because it never changes over the term of the loan. In fact, amortization is at the heart of the standard 30-year, fixed-rate mortgage because it allows people to make a large purchase by spreading manageable monthly payments out over a longer period of time. Other amortized loans include car loans, personal loans, and other installment loans (you pay the loan balance down to zero over time with level payments).

Where people get confused is when they see an amortization table breaking down each month’s payments and they see that the ratio of principle to interest paid off each month changes throughout the life of the loan. Even though you might be paying $350 every month for your mortgage, at the start of the loan term, you’ll be paying more toward interest than principle.

Sometimes it’s easiest to understand an idea when you see it in action. Let’s look at an example of amortization on a loan.

Amortization table example

The table below is an amortization table, or amortization schedule. It’s a great tool to show you how each payment affects the loan, how much you pay in interest each month, and how much you owe on the loan at any given time. 

Imagine the table below represents a $20,000 five-year auto loan at 5 percent interest.

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

You can see that, as time goes on, more of the monthly payment goes toward paying the principle and less toward interest.

When we stretch out a loan over a longer period of time, the starting ratio of interest-to-principal can be a little shocking. See below for an example.

Month

Balance (Start)

Payment

Principal

Interest

Balance (End)

1

$ 300,000

$ 1,610.46

$ 360.46

$ 1,250

$ 299,639.54

2

$ 299,639.54

$ 1,610.46

$ 361.96

$ 1,248.50

$ 299,277.58

3

$ 299,277.58

$ 1,610.46

$ 363.47

$ 1,246.99

$ 298,914.11

4

$ 298,914.11

$ 1,610.46

$ 364.98

$ 1,245.48

$ 298,549.13

. . . .

. . . .

. . . .

. . . .

. . . .

. . . .

357

$ 6,379.32

$ 1,610.46

$ 1,583.88

$ 26.58

$ 4,795.44

358

$ 4,795.44

$ 1,610.46

$1,590.48

$ 19.98

$ 3,204.96

359

$ 3,204.96

$ 1,610.46

$ 1,597.11

$ 13.35

$ 1,607.85

360

$ 1,607.85

$ 1,614.55

$ 1,607.85

$ 6.70

$ 0

Tables like this can help you see how much you’ll pay in interest over the life of a loan, instead of only focusing on a monthly payment. A lower monthly payment sounds enticing, but it actually means you’ll pay more in interest if you stretch out the repayment time. Looking at interest costs, rather than the monthly payment alone, is a better way to measure if you can afford a loan.

In the example shown above, a person with this mortgage would pay a total of $579,769.69over the life of the mortgage, $279,769.69 of which is interest alone—nearly as much as the original loan amount!

To choose a loan and a lender with the best rates, you can use a free online calculator to create an amortization table. It will help you understand how much you could save with a lower rate or a shorter loan term, and how much you’d save if you paid off the debt early.

When selling your home

We’ve seen that during the early years of an amortized loan, you’re paying more toward interest than the loan’s principal. It can take a while before you’re really starting to chip away at the original loan amount. This is important to understand and remember when shopping for a mortgage.

Why? Because although the traditional home loan term is 15 to 30 years, few people keep the same home—and the attached loan—for that long. They usually sell the house or refinance the mortgage before paying the entire loan back. This means that if you sell the house early in the loan term, you’ll have paid off very little of the principal, and so you’ll get a smaller cut of the sale price.

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