How Loan Amortization Works: Understanding Your Monthly Payment
When you take out a fixed-rate loan — a mortgage, car loan, or personal loan — your monthly payment stays the same for the life of the loan. But the split between principal and interest changes every month. Understanding how that split works helps you see exactly where your money is going and why paying extra early saves so much.
The Monthly Payment Formula
The standard amortization formula is M = P × [r(1+r)^n] / [(1+r)^n − 1], where M is the monthly payment, P is the loan principal, r is the monthly interest rate (annual rate ÷ 12), and n is the total number of monthly payments.
For a $250,000 mortgage at 6% for 30 years: r = 0.005, n = 360, M ≈ $1,498.88.
Where Each Payment Goes
Each month, interest is charged on the remaining balance. In month one of the example above, interest is $250,000 × 0.005 = $1,250. That leaves only $248.88 going to principal.
By year 15 the balance has dropped enough that the interest portion is roughly $900 and principal is $600. By the final month, almost the entire payment is principal. This front-loading of interest is why mortgages feel so slow to pay down at first.
The Power of Extra Payments
Because interest is charged on the remaining balance, paying extra early reduces every future interest charge. On the $250k example, adding just $100/month cuts the loan term by about 4 years and saves over $50,000 in interest.
One common strategy: make one extra monthly payment per year (or pay biweekly, which works out to 13 payments a year). It shaves years off most 30-year mortgages.
Term vs Rate Trade-off
A shorter term means higher monthly payments but dramatically less total interest. A 15-year mortgage at the same rate costs much more per month but saves hundreds of thousands over the life of the loan.
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Frequently Asked Questions
Are all loans amortized?
Most installment loans are. Interest-only loans, credit lines, and credit cards work differently.
Does paying extra always help?
Almost always — but check that your loan doesn't charge a prepayment penalty, and confirm extra payments are applied to principal.