Loans and Amortization

Amortization is the schedule that splits a fixed loan payment into two pieces every month: interest, which is the lender's fee on whatever balance is still outstanding, and principal, which actually reduces what you owe. The payment amount never changes — only the ratio between the two pieces does.

Take a $20,000 loan at 6% APR over 60 months — the exact loan the schedule below runs. The fixed monthly payment works out to $386.66. In month one, interest is calculated on the full $20,000 balance: $20,000 × (6% ÷ 12) = $100. The remaining $286.66 of that payment is what actually reduces the balance. Nothing about the $386.66 payment changed — only how it's divided.

Interest is calculated on the remaining balance, and early in a loan the remaining balance is close to the full amount borrowed — so early payments are mostly interest, with only a small sliver going toward principal. Step through the schedule below month by month and watch that ratio flip as the balance shrinks.

Interest's share of that $386.66 payment doesn't creep down in a straight line — it falls fast at first and barely at all near the end, because it tracks a shrinking balance multiplied by a fixed rate.

1. 1

   Month 1 — interest is 25.9% of the payment

   $100 interest, $286.66 principal, on a $19,713.34 remaining balance.

2. 2

   Month 12 — interest is 21.7% of the payment

   $83.83 interest, $302.82 principal, on a $16,463.94 remaining balance.

3. 3

   Month 24 — interest is 16.9% of the payment

   $65.16 interest, $321.50 principal, on a $12,709.78 remaining balance.

4. 4

   Month 36 — interest is 11.7% of the payment

   $45.33 interest, $341.33 principal, on a $8,724.07 remaining balance.

5. 5

   Month 48 — interest is 6.3% of the payment

   $24.27 interest, $362.38 principal, on a $4,492.53 remaining balance.

6. 6

   Month 60 — interest is 0.5% of the payment

   $1.92 interest, $384.73 principal — the final payment clears the loan.

An extra principal payment works by shrinking the balance interest gets calculated on, for every remaining month of the loan. Made early, it prevents interest across nearly the whole remaining term. Made near the end, there are only a handful of months left for it to matter — the same dollar amount, doing far less work.

The effect gets far more dramatic on a longer loan. Take a $300,000 mortgage at 6% APR over 30 years — a standard $1,798.65 monthly payment. Committing to one additional full payment every year, applied directly to principal, changes the shape of the whole loan.

One extra payment a year is thirteen payments instead of twelve — an 8.3% increase in what leaves your account annually, for a saving that's a much larger share of the total interest. That asymmetry is the same mechanic as a single early extra payment, just repeated every year instead of made once.