Amortization

Before you rely on it

What to check

Read the split off your current statement. How far into the term you are decides it.

The common error

Where people go wrong with amortization

Assuming a fixed share of every payment goes to principal. Budgeting a payoff date on that assumption puts people years off, because the early payments build almost no equity at all.

Worked through

Amortization in plain numbers

Borrow $200,000 for 30 years at 6% a year, paid monthly. The payment works out to about $1,199. In month one, interest is 0.5% of $200,000, or $1,000, so only $199 goes toward the balance. In month two, interest is charged on $199,801, so the split shifts by a dime or two. By month 180 the balance has fallen to roughly $142,000, and interest takes about $710 of each payment. In the final year nearly the whole payment is principal. The payment never changes. The mix inside it does, month after month, and that mix is the whole story of how a loan is repaid.

Easily confused

Amortization and its neighbours

Amortization is not the same thing as depreciation, even though both spread a cost over time. Depreciation spreads the cost of an asset you own across its useful life. Amortization on a loan means paying off a debt on a schedule, and the word also turns up in accounting for intangible assets such as patents, which adds to the confusion. On a loan statement it always means the balance is shrinking on schedule; a balloon loan or an interest-only loan is not amortizing, because its payments do not retire the principal. That difference is worth checking before you sign, since the monthly figures can look similar.

In real decisions

Where amortization turns up

Anyone with a mortgage, car loan or student loan lives inside an amortization schedule; it answers how much of the next payment builds equity and how much is rent on the money. It shows the effect of an extra payment, because a dollar paid early stops the interest that would have been charged on it for the rest of the term. Refinancing decisions depend on it too. Restarting a 30-year clock after ten years puts you back at the interest-heavy front of a fresh schedule, and that cost is easy to miss when only the monthly payment is compared.

Know the edges

Where amortization stops being reliable

A standard schedule assumes a fixed rate and a payment made on the due date. Adjustable rates, missed payments, escrow changes and fees on top will each push real numbers away from the table; some lenders apply extra payments to future installments unless told to apply them to principal, so say so in writing. Always read the amortization on your own statement. Day-count rules and rounding can shift the cents even when the structure matches, and the servicer's figure is the one that counts when you pay the loan off.

Quick answers

What people ask about amortization

Does an extra payment shorten the loan or lower the payment? That depends on how the lender applies it. Applied to principal, it shortens the term and cuts total interest while the required payment stays put. Ask your servicer to apply extra money to principal, and confirm it on the next statement.