How Loan Amortization Works: Where Each Payment Goes

How each payment splits

Interest is charged on the balance still owed, so each month's calculation starts with the current balance. Whatever is left of the payment after interest is taken out goes to principal, which lowers the balance for the next month.

1. Interest for the month = current balance × annual rate ÷ 12.
2. Principal repaid = payment − interest.
3. New balance = old balance − principal repaid.

interest = balance × (annual rate ÷ 12)Because the balance falls each month, the interest portion shrinks and the principal portion grows.

A worked schedule

Example: a 200,000 loan at 6.5% over 30 years. Using the payment formula, the monthly payment is 1,264.14.

Month 1: interest is 200,000 × 0.065 ÷ 12 = 1,083.33. Principal is 1,264.14 − 1,083.33 = 180.81, so the new balance is 199,819.19. Month 2: interest is 199,819.19 × 0.065 ÷ 12 = 1,082.35, principal is 181.79, and the balance becomes 199,637.40. Each month the principal share rises a little.

What the schedule shows

• Year one is mostly interest. Across the first 12 payments, about 12,934 goes to interest and only about 2,236 reduces the balance.
• Progress is slow at first. After five years the balance is 187,222, which means about 6.4% of the loan has been repaid even though one sixth of the term has passed.
• The crossover comes late. Principal only overtakes interest at payment 233, a little over 19 years in.
• The total is large. Over the full 30 years the borrower repays about 455,086, of which about 255,086 is interest.

The interest rate sets how steep this effect is. In month 1 of the loan above, 1,083.33 of the 1,264.14 payment, about 86%, is interest. The same 200,000 over 30 years at 3% has a payment of 843.21, and only 500.00 of the first payment, about 59%, is interest. A higher rate means a slower start to repaying principal.

A short loan looks very different. A 12,000 loan at 6% over 12 months has a payment of 1,032.80. The first payment includes 60.00 of interest and the last only 5.14, so principal dominates from the start.

Build your own schedule

You can reproduce any schedule in a spreadsheet with four columns and a few formulas, and it is a good way to test what-if ideas such as a larger payment or a shorter term.

1. Put the amount borrowed, annual rate and number of months in three cells, and work out the payment with the formula.
2. In row one, set the starting balance to the amount borrowed.
3. Compute interest as the balance × rate ÷ 12, principal as the payment minus interest, and the ending balance as the balance minus principal.
4. Set the next row's starting balance to the previous row's ending balance, then copy the row down for every month.

The ending balance on the last row should be zero, give or take a few cents of rounding. If it is not, check that the rate is divided by 12 and the term is in months. The loan calculator produces the same schedule automatically.

Why the split matters

Because interest is calculated on the remaining balance, any reduction in principal early on removes interest from every later month. That is why extra payments made in the first years save far more than the same amount paid near the end.

It also explains why selling or refinancing early may leave you owing more than you expect. After five years of the loan above, you would still owe 187,222 of the original 200,000. A payoff quote from the lender also includes interest accrued since your last payment, so it can differ from the schedule balance.

This is general education about how loans are structured, not financial advice. Your own loan may have different terms, fees or payment timing, so rely on your lender's statements for exact figures.