Understanding Amortization: A Beginner's Guide
Learn how loan amortization works, why your interest payments decrease over time, and how to read an amortization schedule.
What is Loan Amortization?
Amortization is the process of paying off a loan through regular, fixed payments over time. Each payment covers both principal and interest, with the proportion changing throughout the loan tenure.
How Amortization Works
In the early stages of your loan:
- A larger portion of your EMI goes toward interest
- A smaller portion reduces the principal
- Outstanding balance decreases slowly
As you progress through the loan:
- Interest portion gradually decreases
- Principal portion increases
- Outstanding balance reduces faster
Reading an Amortization Schedule
An amortization schedule shows you:
- Payment Number: Which month of the loan you're in
- EMI Amount: Your fixed monthly payment
- Principal Component: Amount reducing your loan balance
- Interest Component: Amount paid as interest
- Outstanding Balance: Remaining loan amount after each payment
Why Interest Decreases Over Time
Interest is calculated on the outstanding principal balance. As you pay down the principal, the interest charged each month decreases, allowing more of your EMI to go toward principal reduction.
Benefits of Understanding Amortization
- See exactly where your money goes each month
- Understand the impact of prepayments
- Make informed decisions about loan tenure
- Plan your finances more effectively
- Identify the best time to refinance
Practical Example
For a $200,000 loan at 7% interest for 30 years:
- Month 1: EMI $1,330 (Interest: $1,167, Principal: $163)
- Month 180: EMI $1,330 (Interest: $815, Principal: $515)
- Month 360: EMI $1,330 (Interest: $8, Principal: $1,322)
Use our calculator to generate your personalized amortization schedule and see how your loan payments break down over time.