What Is Loan Amortization?
5 Min Read | Published: May 29, 2024
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With an amortized loan, payments are applied to both the principal and interest. Learn how amortization works and calculate your amortization schedule.
At-A-Glance
- With an amortized loan, most of your monthly payment will typically go to repaying interest initially, but later on, more will be applied toward the principal.
- Amortization allows payments to remain consistent throughout the life of the loan, allowing you to easily budget for your loan repayments.
- Loan amortization can clearly define how much you’ll pay in interest over the life of the loan.
If you’d like to take out a mortgage, auto loan, or another type of installment loan, it’s important to understand the concept of loan amortization. In this article, we explain how loan amortization works, discuss how it affects monthly payments, and show you how you can calculate it.
What Is Loan Amortization?
Loan amortization refers to the process of breaking up a loan into a schedule of repayments based on the loan amount, the loan term, and the interest rate.
With an amortized loan, a higher percentage of the repayments will typically go toward interest in the beginning. Later on, however, more will go toward the principal.1
One of the reasons lenders may structure loans this way is because it allows your payments to remain consistent, even though the percentage of funds that are allocated for interest and the principal will change over time.
What Is a Loan Amortization Schedule?
A loan amortization schedule is a table that lays out all of the scheduled payments on a loan. It can tell you exactly how much of each of your payments will go toward principal or interest at different times throughout the loan term. The factors that typically impact a loan amortization schedule include:2
- Loan Details: The loan amount, loan term, and interest rate.
- Payments: The amount of your payments and how often you make them. Monthly payments are the most common.
- Total Loan Payments: The total number of payments you’re expected to make during the loan term.
- Loan Principal Amount: The amount of your monthly payments that will go to paying off your loan principal amount. This number will increase over the life of your loan.
- Interest: The number of your monthly payments that will be applied toward the interest portion of your loan. This number will decrease over the life of your loan.
- Outstanding Balance: The outstanding balance on the loan after you make each scheduled payment.
Let’s say you take out a $50,000 loan, assuming it has a 6-year term and 6% interest rate. Here’s what your loan amortization schedule may look like:3
| Year | Interest | Principal | Ending Balance |
|---|---|---|---|
| 1 | $2,805.83 | $7,137.90 | $42,862.10 |
| 2 | $2,365.58 | $7,578.15 | $35,283.94 |
| 3 | $1,898.17 | $8,045.56 | $27,238.38 |
| 4 | $1,401.94 | $8,541.79 | $18,696.59 |
| 5 | $875.10 | $9,068.63 | $9,627.96 |
| 6 | $315.77 | $9,627.96 | $-0.00 |
As you can see, the percentage of the monthly payment that is allocated to interest decreases over time, while the amount that is going toward the principal increases.
How to Calculate Loan Amortization
An online loan amortization calculator can make it a breeze to calculate loan amortization. All you have to do is plug in your loan amount, interest rate, and repayment term.
You should be able to find this information in your loan agreement. If you’re unable to, don’t hesitate to contact your lender. Your lender may also provide you with a loan amortization schedule as well.
What Is the Benefit of Loan Amortization?
Loan amortization can give you a good idea of how your loan repayment will work over time. You can look at your amortization schedule at any given month to determine how much of your payment will go toward the principal and how much will be applied to interest.
You’ll also be able to see your outstanding balance, so you know how much more you have to pay until the loan is paid off. By understanding loan amortization, you’ll find it easier to manage your finances and be able to design a debt repayment plan that aligns with your unique budget and financial goals
Did you know?
There are many types of amortizing loans, including fixed-rate mortgages, auto loans, home equity loans, personal loans, and student loans.4
Frequently Asked Questions
An amortized loan includes principal payments and interest that are spread out over the loan’s term. With an interest-only loan, however, you only have to make interest payments, which means your payments may be lower. However, your payment does not pay off the loan’s balance, unless you pay more than the minimum each month.5 Note that this will vary, depending on how the loan is structured).
The best loan option for you will depend on the type of loan you’re getting, and the terms of the loan in question. One of the main differences between amortizing loans and simple interest loans is that with amortizing loans, the amount that you pay toward interest decreases over time. With a simple interest loan, on the other hand, your interest remains consistent throughout the term of the loan.6
The Takeaway
Loan amortization refers to a series of fixed, regular payments that go toward both the principal and interest until a loan is repaid in full. At first, typically most of the payment will be applied to interest charges. As you get closer to the end of your term, more will go toward the principal. Loan amortization can help you budget for a loan appropriately and keep your finances in check.
1,2 “What Is an Amortized Loan?,” Experian
3 “Amortization Calculator,” Calculator.net
4 “What Is Loan Amortization?,” Forbes
5 “Amortized vs. Interest-Only Payments,” LoanBase
6 “Amortization Vs. Simple Interest Loans: Choosing The Right Option,” REIL Capital
Anna Baluch is a personal finance writer from Cleveland, OH. She enjoys helping people from all walks of life make smart financial decisions. Her work can be seen on Credit Karma, Forbes, LendingTree, Insurify, and many other publications. Connect with Anna on LinkedIn.
All Credit Intel content is written by freelance authors and commissioned and paid for by American Express.
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