Amortization Formula
where P = principal, r = monthly rate, n = total payments
Interest portion = Balance × monthly rate
Principal portion = Payment − Interest
How Amortization Works
In an amortizing loan, each payment covers the interest accrued that month, and the remainder reduces the principal balance. Early payments are mostly interest; later payments are mostly principal. This is why paying extra early dramatically reduces total interest.
Example: $200,000 Mortgage at 6.5% for 30 Years
| Payment # | Principal | Interest | Balance |
|---|---|---|---|
| 1 | $175 | $1,083 | $199,825 |
| 60 (5 yr) | $211 | $1,048 | $192,038 |
| 180 (15 yr) | $316 | $943 | $172,958 |
| 360 (final) | $1,254 | $7 | $0 |
Total interest paid: ~$255,000 — more than the original loan amount.
Frequently Asked Questions
What is negative amortization?
Negative amortization occurs when the minimum payment doesn't cover the full interest due. The unpaid interest gets added to the principal balance — the loan grows instead of shrinking. This happened with many adjustable-rate mortgages before 2008. Standard fixed-rate amortizing loans don't have this problem.
How much does making one extra payment per year save?
On a 30-year mortgage, making one extra payment per year typically saves 4–6 years of payments and tens of thousands of dollars in interest. For a $200,000 mortgage at 6.5%, one extra payment per year saves approximately $40,000 in interest and pays off ~4 years early.
What is the difference between amortization and depreciation?
Amortization spreads loan repayment over time (finance). Depreciation spreads the cost of a tangible asset over its useful life (accounting). Both use the same spreading concept, but amortization applies to debts/intangible assets while depreciation applies to physical assets.