Loan Amortization
Loan amortization describes the gradual repayment of a loan through scheduled monthly payments that include both interest and principal. Each payment reduces the outstanding balance, with the proportion of principal increasing over time and the proportion of interest decreasing.
Lenders often provide borrowers with an amortization schedule, which is a detailed table showing the breakdown of each payment over the life of the loan. Understanding amortization is crucial for borrowers to see how much of their money is going toward interest versus reducing the loan balance.
Amortization also explains why making extra payments toward principal early in the loan can significantly reduce total interest costs and shorten the loan term. The concept applies universally across auto loans, mortgages, and personal loans, but it is particularly important in auto financing because cars depreciate quickly.
By studying an amortization schedule, borrowers can determine strategies such as bi-weekly payments, rounding up monthly payments, or applying windfalls directly to principal. These techniques accelerate payoff and save money.
Ultimately, amortization provides transparency into repayment progress and highlights the benefits of disciplined repayment strategies.
Formula
Monthly Payment = [P × r(1 + r)^n] ÷ [(1 + r)^n – 1], where P = principal, r = monthly interest rate, n = number of paymentsExample
Samantha finances $22,000 for 60 months at 5% interest. Her amortization schedule shows that in the first month, $183 of her $415 payment goes toward interest and $232 goes toward principal. By the last month, nearly the entire payment applies to principal.