What is Amortization?
The Simple Definition
Amortization is the process of paying off a debt (like a mortgage or car loan) over time through regular, equal monthly payments.
Even though your monthly payment stays the exact same every month, the way that payment is split between Principal (the actual money you owe) and Interest (the bank's profit) changes every single month.
How an Amortization Schedule Works
Lenders front-load the interest. In the early years of an amortized loan, almost your entire monthly payment goes toward paying interest, and very little goes toward paying down your actual balance.
As the years go on and your principal balance slowly shrinks, the interest charge shrinks with it. By the final years of the loan, almost your entire monthly payment is going toward the principal.
In Year 1, out of a $2,000 monthly payment, $1,600 might go to Interest, and only $400 goes to Principal.
In Year 29, out of that same $2,000 monthly payment, only $50 goes to Interest, and $1,950 goes to Principal.
How to Beat Amortization
Because the bank front-loads the interest, the best way to beat an amortized loan is to make extra principal payments early in the loan.
If you pay an extra $100 toward principal in Month 1, you permanently destroy all the future interest that $100 would have generated over the next 30 years. This is why making extra mortgage payments can shave a decade off your loan. Check out our Mortgage Payoff Calculator to see the math in action.