Definition
An Amortization Schedule is a detailed breakdown of a loan’s repayment over time, showing how each monthly payment is divided between principal and interest. This schedule helps borrowers understand how much of their payment reduces their loan balance (principal) versus how much goes toward interest.
Explanation
Mortgages and other long-term loans typically follow an amortization schedule, where payments remain fixed, but the portion applied to principal and interest changes over time. In the early years of the loan, most of the payment goes toward interest, while in later years, more of the payment reduces the principal balance.
Key Features of an Amortization Schedule:
- Fixed monthly payments (for most traditional mortgages).
- Gradual reduction of loan balance over time.
- Higher interest payments at the beginning, lower interest toward the end.
Formula for Loan Amortization:
M = P × ( r(1+r)^n / (1+r)^n − 1 )
Where:
- M = Monthly Payment
- P = Principal Loan Amount
- r = Monthly Interest Rate (Annual Rate ÷ 12)
- n = Total Number of Payments (Loan Term in Months)
Example of an Amortization Schedule
For a $300,000 loan with a 30-year term at 5% interest, the monthly payment (excluding taxes & insurance) is $1,610. The first few payments are:
| Payment # | Principal Paid | Interest Paid | Remaining Balance |
|---|---|---|---|
| 1 | $360 | $1,250 | $299,640 |
| 12 | $380 | $1,230 | $295,200 |
| 120 | $700 | $910 | $246,800 |
| 360 (Final) | $1,600 | $10 | $0 (Loan Paid Off) |
Over 30 years, the total interest paid on a $300,000 loan at 5% is about $279,000, nearly doubling the cost of the loan.
Benefits of Understanding Amortization:
✅ Helps borrowers plan finances and track loan progress.
✅ Encourages extra principal payments to reduce total interest paid.
✅ Shows how early refinancing or extra payments can save money.
Example of an Extra Payment Strategy
If the borrower adds $200/month toward principal, they can:
- Pay off the mortgage 5–7 years early.
- Save over $50,000 in interest costs.