Understanding Amortization – and How It Impacts Your Loans!
While a loan’s term, balance, and interest rate help to determine your monthly payments and how they break down, the loan’s amortization is another important consideration in this financial picture.
By understanding amortization, you can improve your debt management strategy and reduce the amount of interest you’ll pay in the long run! Here’s how it works.
Loan Payments and Amortization: The Basics
As a borrower, your loan payments can go toward principal and interest. If you’re not paying the interest in full each month, it accumulates along with any applicable fees. That’s why financial institutions will always define an APR, or annual percentage rate, when you receive a loan offer – to make sure it’s crystal clear how much interest and fees will accrue on your loan per year. It’s also why you should have a loan payment strategy.
A good baseline strategy for paying down any loan, line of credit, or credit card is to ensure that your monthly payment will cover any new interest or fees plus some of the principal. The more principal you can pay, the less interest you’ll accrue, and the faster you could pay it off!
The schedule by which a loan’s principal and interest get paid off is known as amortization.
Fully Amortizing Loans
For most fixed-rate installment loans, the amortization schedule aligns with the term, meaning that the total loan balance will be paid off over the life of the loan. For example, a 30-Year Fixed-Rate Mortgage can be paid off, or fully amortized, at the end of those 30 years by simply sticking to the minimum payments. Additional payments can help you pay it off sooner, though, and with less interest!
Compare the following amortization schedules for a 30-year, fixed-rate mortgage of $200,000. For this example, we’ll consider a 7% interest rate (or 7.242% APR)*. Now, let’s see how adding an additional $50 per month on top of the minimum payment of $1,331 can impact the payoff.
| Month | Payment | Interest Per Month | Cumulative Interest | Remaining Balance |
| 1(A) | $1,331 | $1,167 | $1,167 | $199,836 |
| 1(B) | $1,381 | $1,167 | $1,167 | $199,786 |
| 60 (A) | $1,331 | $1,100 | $68,099 | $188,263 |
| 60 (B) | $1,381 | $1,079 | $67,520 | $184,684 |
| 120 (A) | $1,331 | $1,003 | $131,297 | $171,625 |
| 120 (B) | $1,381 | $953 | $128,643 | $162,971 |
| 180 (A) | $1,331 | $866 | $187,547 | $148,038 |
| 180 (B) | $1,381 | $775 | $180,699 | $132,190 |
| 240 (A) | $1,331 | $672 | $233,945 | $114,600 |
| 240 (B) | $1,381 | $522 | $219,899 | $88,554 |
(A) is paid off in 360 months with $279,018 total interest paid.
(B) is paid off in 321 months with $242,589 total interest paid.
*APR = Annual Percentage Rate. Rates used in this article are used for educational purposes only; actual rates may vary.
Even with regular monthly payments (A) on this mortgage, you’ll notice that the distribution of each payment differs in how much applies toward principal versus interest. Note how things change with the increased payment (B), particularly in the amount of interest per month and cumulative interest.
Around five years into the loan, you’d already be saving about $21 per month in interest. By the time you’re 10 years into the loan, you’d be saving $50 per month in interest, which means your whole additional payment is already paying off in savings! Looking ahead to the 20-year mark, you’d be saving $150 per month in interest compared to the minimum payments. Not only could you pay off the mortgage more than three years earlier, but you also could save a total of $36,429 in interest!
Bulk payments have a similar impact, especially if you’re able to apply that bulk payment early in the term, by reducing the amount of interest that accrues monthly.
Other Types of Amortization
Keep in mind, not all loans amortize in the same way. Credit cards, Home Equity Lines of Credit (HELOCs), and commercial loans are likely to have different amortization schedules that don’t fully amortize with minimum payments. For example, by only paying the minimum on a credit card with a high balance, you’re likely to extend your payoff window.
In any case, become familiar with your loans’ repayment schedules and aim to pay above the minimum. The sooner you pay it off, and the more you can pay up front, the more you’re setting yourself up for savings and financial success.
Resources for Mortgages and Debt Management
Let us know how we can support your financial goals. Here are a handful of resources to help you get started:
- Discover more debt management tips in Wallet Wellness
- For information about our fixed-rate or adjustable-rate mortgages (ARMs), check out our Mortgages
- Explore your payment strategy with our mortgage and loan calculators
You can discuss these topics and more with representatives in our Contact Center at 800.242.2120 or at your local branch.
This article first appeared in MoneyMatters Magazine. Click here to continue reading our current publication.
