Borrowing
Learn how loan amortization works, how each payment is split between principal and interest, and how your remaining balance changes over time. Explore the interactive example below.
Amortization is the process of paying off a loan over time through scheduled payments.
With many installment loans, each payment includes both principal and interest. Principal reduces the amount you owe, while interest represents the cost of borrowing money.
Although the payment may remain the same, the amount going toward principal and interest can change over the life of the loan.
At the beginning of an amortizing loan, a larger portion of each payment generally goes toward interest because the outstanding loan balance is higher.
As the balance decreases, the amount of interest charged generally decreases as well. This allows more of the payment to go toward principal.
Over time, the loan balance continues to fall until the loan is fully repaid.
Key terms
Understanding these terms makes it easier to see what happens during loan repayment.
The amount of money borrowed, excluding interest and other borrowing costs.
The cost of borrowing money, typically calculated using the outstanding loan balance and interest rate.
The scheduled amount paid each month toward principal and interest.
The amount of principal that remains unpaid at a particular point in the loan.
A table showing how scheduled payments are divided between principal and interest and how the loan balance changes over time.
Each payment can be divided into interest and principal. Interest is calculated using the outstanding balance, while the remaining portion of the payment reduces the principal.
The interest charged for the current payment.
The outstanding loan balance before the current payment is applied.
The annual interest rate converted to a monthly decimal rate.
The portion of the payment that reduces the outstanding loan balance.
The scheduled principal-and-interest payment.
The remaining loan balance after the current payment is applied.
For example, if the remaining balance is $280,000 and the annual interest rate is 6.5%, the monthly rate is approximately 0.005417. Using the unrounded monthly rate, the interest for the first payment is approximately $1,516.67. The rest of the monthly principal-and-interest payment reduces the loan balance.
Each payment can contain both principal and interest, but their proportions can change as the loan is repaid.
The principal portion of a payment reduces the outstanding loan balance.
The interest portion represents the cost of borrowing money based on the outstanding balance.
With a typical fixed-rate amortizing loan, the total principal-and-interest payment may remain the same while the proportions going toward principal and interest change over time.
Try it yourself
Move through the loan to see how the same monthly payment can be divided differently between principal and interest.
Interest = $280,000 × (6.5% ÷ 12) ≈ $1,516.67
Principal = $1,769.79 − $1,516.67 ≈ $253.12
This is a simplified educational example of a fixed-rate amortizing loan. It shows principal and interest only. Actual loan calculations, fees, payment timing, and lender practices can affect repayment amounts.
What changed and why?
Move through the loan to see how the composition of each payment changes over time. Earlier payments generally contain more interest because the outstanding balance is higher.
The monthly principal-and-interest payment can remain the same even though its composition changes.
A larger portion of the payment generally goes toward interest because the outstanding balance is higher.
As the balance decreases, less interest is generally charged and more of the payment can go toward principal.
Key takeaway
Amortization gradually reduces a loan balance through scheduled payments. With a typical fixed-rate amortizing loan, the payment can remain the same while the amounts going toward principal and interest change over time.
Earlier payments generally contain more interest, while later payments generally contain more principal.
Continue learning
Continue learning how loans, repayment, and financing costs work.