What Is Amortization?

The idea

Every payment has two jobs: cover the interest that accrued this month, and use whatever is left to reduce the balance. Because the balance shrinks, next month's interest is slightly smaller, so slightly more of the same payment reaches the principal.

That feedback loop is amortization. Nothing changes except the split — and the split is what matters.

Reading an amortization schedule

A schedule lists every payment with four columns. For payment #1 on $20,000 at 8% for 5 years:

• Payment: $405.53 (fixed for all 60 rows)
• Interest: $133.33 (= 20,000 × 8% ÷ 12)
• Principal: $272.20 (= payment − interest)
• Remaining balance: $19,727.80

Why extra payments punch above their weight

An extra $100 paid early doesn't just remove $100 of debt — it removes every future interest charge on that $100 for the rest of the term. On a 30-year mortgage, an extra payment in year one can save several times its own value in interest.

Most loans apply extra payments to principal only if you say so; check your lender's rules about prepayment and how to designate it.

Where you'll meet the word elsewhere

In accounting, amortization also means spreading the cost of an intangible asset (like a patent) over its useful life — the same core idea of converting one amount into a schedule of smaller amounts over time.