Amortization
Paying off a loan with regular equal payments that cover interest first and gradually reduce principal to zero by the end of the term.
What it means
An amortizing loan, such as a typical mortgage, auto loan or personal loan, has a fixed payment calculated so the balance reaches zero on the final payment. Each payment first covers the interest accrued on the current balance, and the rest reduces principal. As the balance falls, the interest share shrinks and the principal share grows.
An amortization schedule lists every payment and its split. It shows why early payments build little equity and how extra principal payments shorten the loan. In accounting, the word also means spreading the cost of an intangible asset over time, a separate use.
Formula
M = P × r ÷ (1 − (1 + r)^(−n))
- M = periodic payment
- P = loan principal
- r = interest rate per period (annual rate ÷ 12 for monthly)
- n = total number of payments
Example
Suppose you borrow $200,000 for 30 years at 6%. With r = 0.005 and n = 360, the monthly payment is about $1,199.10. In month one, $1,000 is interest and $199.10 goes to principal. Over the full term you would pay about $231,676 in interest.
How it’s used
- Understanding mortgage and car loan payments
- Seeing how extra payments shorten a loan
- Comparing 15-year and 30-year loan costs
Related terms
Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.