Amortization
BankingDefinition
Amortization is the process of paying off a loan through regular, fixed payments over a set period. Each payment is split between interest and principal, but the split changes dramatically over time.
In the early years of a mortgage, the vast majority of your payment goes to interest because the outstanding balance is large. As you pay down the principal, less interest accrues each month, and more of your payment goes toward actually reducing what you owe. This is why extra payments in the early years have such a massive impact - every extra dollar goes straight to principal, saving you years of future interest.
This front-loaded interest structure is why banks love 30-year mortgages. In the first 10 years of a 30-year mortgage at 6.5%, you will have paid about $190K in interest but only reduced your principal by about $40K.
In the early years of a mortgage, the vast majority of your payment goes to interest because the outstanding balance is large. As you pay down the principal, less interest accrues each month, and more of your payment goes toward actually reducing what you owe. This is why extra payments in the early years have such a massive impact - every extra dollar goes straight to principal, saving you years of future interest.
This front-loaded interest structure is why banks love 30-year mortgages. In the first 10 years of a 30-year mortgage at 6.5%, you will have paid about $190K in interest but only reduced your principal by about $40K.
How it works
Payment split over time
Year 1Year 8Year 15Year 22Year 30
InterestPrincipal
Example
$320,000 mortgage at 6.5% for 30 years: Monthly payment = $2,023. Month 1: $1,733 goes to interest, only $290 to principal. Month 180 (year 15): $1,174 to interest, $849 to principal. Month 360 (final): $11 to interest, $2,012 to principal.
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