What is amortization?
Amortization is the technique of paying a loan over a set schedule of payments. A portion of each payment goes to the loan amount, known as the principal, and the other portion goes toward interest. The portion of the money that goes towards the principal lowers the amount left on the loan. Interest is what the lender charges you for using the loan.
For example, if you have a $1,000 loan make a monthly payment of $110, where $100 goes toward the principal and $10 goes towards interest, the new principle on the loan is $900.
For fixed-rate loans, which are common for mortgages, the monthly payment for the loan stays the same, but the amount of money goes towards principal and interest charges over the life of the loan. Because you have a large principal at the beginning of the loan you pay more in interest at the beginning of the loan and less interest towards the end of the loan.
How to calculate amortization
The most simple way to calculate amortization is to use the calculator at the top of this page. Otherwise, you can use the amortization formula below.
The formula for amortization is:
- P is the principal amount borrowed
- A is the periodic amortization payment
- r is the periodic interest rate divided by 100 (nominal annual interest rate also divided by 12 in case of monthly installments)
- n is the total number of payments (for a 30-year loan with monthly payments n = 30 × 12 = 360).
What is an amortization schedule?
An amortization shows you the payment total for each month along with the funds going towards the loan’s principal and interest for each month. Amortization schedules help you determine how much interest you pay for each payment and how much interest you pay for the life of the loan. The total amount of interest for the loan is equivalent to how much the loan costs in addition to the principal. The total cost of the loan is the amount of interest plus the amount of initial principal.
For example, if you have a $10,000 loan at 5% interest for 12 months you will pay $272.90 in interest. The total cost of the loan is $10,272.90