Understanding Amortization

A practical method

Amortization is the scheduled repayment of a balance through periodic payments. For a typical fixed-rate fully amortizing loan, the payment stays constant while its composition changes: interest is calculated on the remaining principal, and the rest reduces that principal. Early payments therefore contain more interest than later payments.

1. Convert the annual rate: Divide the nominal annual rate by the number of payment periods when that matches the loan convention.
2. Calculate periodic interest: Multiply the opening balance by the periodic rate.
3. Find principal repaid: Subtract the interest portion from the scheduled payment.
4. Update the balance: Subtract principal repaid, then repeat for the next period.

Worked example

If a monthly payment is $600 and the first month's interest is $400, only $200 reduces principal. If the next month's interest falls to $398 while the payment remains $600, principal repayment rises to $202. Small changes accumulate across the schedule.

Checks, edge cases, and common mistakes

• The advertised rate, payment frequency, fees, and compounding convention must match the model.
• A balloon loan or interest-only period is not fully amortizing.
• Extra principal payments can change the payoff date even when the scheduled payment is unchanged.
• Use the lender's official schedule for contractual amounts; calculator results are estimates.