What is amortization and how does it work?
Amortization is the process of spreading out a loan into a series of fixed payments. The loan is paid off at the end of the payment schedule.
The best way to understand amortization is by reviewing an amortization table. If you have a mortgage, the table was included with your loan documents.
An amortization table is a schedule that lists each monthly loan payment as well as how much of each payment goes to interest and how much to the principal. Every amortization table contains the same kind of information:
- Scheduled payments: Your required monthly payments are listed individually by month for the length of the loan.
- Principal repayment: After you apply the interest charges, the remainder of your payment goes toward paying off your debt.
- Interest expenses: Out of each scheduled payment, a portion goes toward interest, which is calculated by multiplying your remaining loan balance by your monthly interest rate.
Although your total payment remains equal each period, you'll be paying off the loan's interest and principal in different amounts each month. At the beginning of the loan, interest costs are at their highest. As time goes on, more and more of each payment goes towards your principal and you pay proportionately less in interest each month.