Understanding Amortization: How Loans Really Work

Most people don't understand where their monthly mortgage or car payment actually goes. They assume each payment chips away equally at the principal. In reality, amortization means most of your early payments go to interest, not principal.

How Amortization Works

An amortization schedule breaks down each monthly payment into two parts: principal (what reduces your debt) and interest (what the lender keeps). The split changes every month—early payments are mostly interest, later payments are mostly principal.

For a $300,000 mortgage at 7% over 30 years, your payment is $1,996/month. But in month 1:

• Interest: $1,750
• Principal: $246

You're paying $1,750 (87.7%) to the bank just for borrowing money! In month 360 (the last payment):

• Interest: $12
• Principal: $1,984

Why Early Extra Payments Matter

If you pay an extra $100/month on your mortgage, it goes entirely to principal (reducing future interest). This can cut about 4 years off your loan and save ~$69,000 in interest over 30 years.

Early payments on principal compound over time—they reduce the balance that future interest is calculated on, which reduces future interest charges, which lets more of future payments go to principal. It creates a snowball effect in reverse.

Practical Takeaway

If you can afford it, make extra principal payments early in your loan. A $100 extra payment in year 1 saves more than a $100 payment in year 25. Check your loan documents to ensure extra payments aren't penalized, then use our calculators to model how much you'll save.