What Is Amortization?

What Is Amortization?

Amortization is the process of paying off a debt through regular, scheduled payments over time. On an amortizing loan, each payment covers both interest charged since the last payment and a portion of the principal balance. Over the life of the loan, the principal balance decreases to zero, and the loan is fully repaid.

How Amortization Works

On a fixed-rate amortizing loan, your monthly payment remains constant throughout the term, but the split between interest and principal changes with each payment. In the early months, most of each payment covers interest because the outstanding balance is high. As the balance decreases, less interest accrues, and more of each payment reduces principal. This gradual shift is visible in the amortization schedule.

The Amortization Formula

M = P[r(1+r)^n] / [(1+r)^n - 1], where P is the principal, r is the monthly interest rate, and n is the number of payments. Each row of the amortization schedule uses the remaining balance from the prior row to calculate that period's interest charge, which is why early payments are mostly interest and later payments are mostly principal.

Negative Amortization

Negative amortization occurs when the scheduled payment is less than the interest that accrues in that period, causing the outstanding balance to increase. This can happen with certain adjustable-rate mortgages and income-driven student loan repayment plans. The unpaid interest is capitalized (added to the principal).