Amortization is how you pay off a loan (like a mortgage, car loan, or student loan) with a series of regular, equal payments over time. Each payment covers both the interest you owe and part of the loan principal (the amount you borrowed).
How Amortization Works
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You make regular payments:
Every month, you pay the same amount until the loan is paid off. -
Each payment has two parts:
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Interest: What you pay for borrowing the money
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Principal: The amount that goes toward paying down your loan balance
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Early payments = more interest, less principal:
At the start, most of your monthly payment covers interest. As you pay down the principal, more of each payment goes toward the principal and less toward interest.
The Amortization Formula
You can calculate your monthly payment with this formula:
Monthly Payment (M) = [P × r × (1 + r)^n] / [(1 + r)^n – 1]
Where:
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M = monthly payment
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P = principal (the loan amount)
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r = monthly interest rate (annual rate divided by 12)
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n = number of total payments (months)
Example Calculation
Let’s say:
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You borrow $200,000 (P)
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The annual interest rate is 6%
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The loan term is 30 years (360 months)
First, convert the interest rate:
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Monthly rate (r): 6% ÷ 12 = 0.5% per month, or 0.005 as a decimal
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Number of payments (n): 30 × 12 = 360
Plug into the formula:
Monthly Payment (M) = [200,000 × 0.005 × (1 + 0.005)^360] / [(1 + 0.005)^360 – 1]
This formula gives you the fixed monthly payment amount.
What Is an Amortization Schedule?
An amortization schedule is a table that shows every payment you’ll make, with columns for:
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The payment number
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How much goes to interest
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How much goes to principal
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The remaining loan balance
It helps you see how your loan balance drops and how much interest you pay over time.
Why Amortization Matters
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Predictable Payments: You always know what you owe each month.
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Interest vs. Principal: Shows how much of your payment goes toward owning your home (or other asset) over time.
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Total Interest: Helps you understand the real cost of borrowing.