Loan amortization is the process of scheduling out a fixed-rate loan into equal payments. A portion of each installment covers interest and the remaining portion goes toward the loan principal. The easiest way to calculate payments on an amortized loan is to use a loan amortization calculator or table template. However, you can calculate minimum payments by hand using just the loan amount, interest rate and loan term.
Lenders use amortization tables to calculate monthly payments and summarize loan repayment details for borrowers. However, amortization tables also enable borrowers to determine how much debt they can afford, evaluate how much they can save by making additional payments and calculate total annual interest for tax purposes.
What Is an Amortized Loan?
An amortized loan is a form of financing that is paid off over a set period of time. Under this type of repayment structure, the borrower makes the same payment throughout the loan term, with the first portion of the payment going toward interest and the remaining amount paid against the outstanding loan principal. More of each payment goes toward principal and less toward interest until the loan is paid off.
Loan amortization determines the minimum monthly payment, but an amortized loan does not preclude the borrower from making additional payments. Any amount paid beyond the minimum monthly debt service typically goes toward paying down the loan principal. This helps the borrower save on total interest over the life of the loan.
Types of Amortizing Loans
Amortizing loans include installment loans where the borrower pays a set amount each month and the payment goes to both interest and the outstanding loan principal. Common types of amortizing loans include:
Amortized Loans Vs. Unamortized Loans
With an amortized loan, principal payments are spread out over the life of the loan. This means that each monthly payment the borrower makes is split between interest and the loan principal. Because the borrower is paying interest and principal during the loan term, monthly payments on an amortized loan are higher than for an unamortized loan of the same amount and interest rate.
A borrower with an unamortized loan only has to make interest payments during the loan period. In some cases the borrower must then make a final balloon payment for the total loan principal at the end of the loan term. For this reason, monthly payments are usually lower; however, balloon payments can be difficult to pay all at once, so it’s important to plan ahead and save for them. Alternatively, a borrower can make extra payments during the loan period, which will go toward the loan principal.
Examples of common unamortized loans include:
- Interest-only loans
- Credit cards
- Home equity lines of credit
- Loans with a balloon payment, such as a mortgage
- Loans that permit negative amortization where a monthly payment is less than the interest accrued during the same period
How Loan Amortization Works
Loan amortization breaks a loan balance into a schedule of equal repayments based on a specific loan amount, loan term and interest rate. This loan amortization schedule lets borrowers see how much interest and principal they will pay as part of each monthly payment—as well as the outstanding balance after each payment.
A loan amortization table can also help borrowers:
- Calculate how much total interest they can save by making additional payments
- Reverse engineer a loan payment to determine how much financing they can afford
- Calculate the total amount of interest paid in a year for tax purposes (this applies to mortgages, student loans and other loans with tax-deductible interest)
How to Amortize Loans
The easiest way to amortize a loan is to use an online loan calculator or template spreadsheet like those available through Microsoft Excel. However, if you prefer to amortize a loan by hand, you can follow the equation below. You’ll need the total loan amount, the length of the loan amortization period (how long you have to pay off the loan), the payment frequency (e.g., monthly or quarterly) and the interest rate.
To calculate the monthly payment on an amortized loan, follow this equation:
a / {[(1 + r)n]-1} / [r (1+r)n] = p, where
a: the total amount of the loan
r: the monthly interest rate (annual rate / number of payments per year)
n: the total number of payments (number of payment per year x length of loan in years)
Consider a $15,000 auto loan extended at a 6% interest rate and amortized over two years. The calculation would be as follows:
$15,000 / {[(1+0.005)24]-1} / [0.005(1+0.005)24] = $664.81 per month
Then, calculate how much of each payment will go toward interest by multiplying the total loan amount by the interest rate. If you will be making monthly payments, divide the result by 12—this will be the amount you pay in interest each month. Determine how much of each payment will go toward the principal by subtracting the interest amount from your total monthly payment.
To calculate the outstanding balance each month, subtract the amount of principal paid in that period from the previous month’s outstanding balance. For subsequent months, use these same calculations but start with the remaining principal balance from the previous month instead of the original loan amount.
To amortize the loan in the example above, first calculate how much you’ll pay in interest each month by multiplying $15,000 by 6%—in this case $900—and then dividing by 12 monthly payments. In this case, the borrower will pay $75 in interest during the first month [$15,000 x 0.06 / 12 = $75].
What Is an Amortization Table?
An amortization table lists all of the scheduled payments on a loan as determined by a loan amortization calculator. The table calculates how much of each monthly payment goes to the principal and interest based on the total loan amount, interest rate and loan term. You can build your own amortization table, but the simplest way to amortize a loan is to start with a template that automates all of the relevant calculations.
Amortization tables typically include:
- Loan details. Loan amortization calculations are based on the total loan amount, loan term and interest rate. If you are using an amortization calculator or table, there will be a place to enter this information.
- Payment frequency. Typically, the first column in the amortization table lists how frequently you’ll make a payment, with monthly being the most common.
- Total payment. This column includes the borrower’s total monthly payment. If you use an amortization table template, this number will be calculated for you. You also can calculate it by hand or by using a personal loan calculator.
- Extra payment. If the borrower makes a payment beyond the minimum monthly amount, the amortization calculator will apply the extra amount to the principal and calculate future interest payments based on the updated balance.
- Principal repayment. This part of the amortization table shows how much of each monthly payment goes toward paying off the loan principal. This number increases over the life of the loan.
- Interest costs. Likewise, the interest column of an amortization table tracks how much of each payment goes toward loan interest. Monthly interest payments decrease over the life of an amortized loan.
- Outstanding balance. This column shows the outstanding balance on the loan after each scheduled payment and is calculated by subtracting the amount of principal paid in each period from the current loan balance.
Amortization Loan Table Example
The amortization table is built around a $15,000 auto loan with a 6% interest rate and amortized over a period of two years. Based on this amortization schedule, the borrower would be responsible for paying $664.81 each month, and the monthly interest payment would start at $75 in the first month and decrease over the life of the loan. Absent any additional payments, the borrower will pay a total of $955.42 in interest over the life of the loan.
| Month | Beginning balance | Interest | Principal | Ending balance |
|---|---|---|---|---|
| 1 | $15,000.00 | $75.00 | $589.81 | $14,410.19 |
| 2 | $14,410.19 | $72.05 | $592.76 | $13,817.43 |
| 3 | $13,817.43 | $69.09 | $595.72 | $13,221.71 |
| 4 | $13,221.71 | $66.11 | $598.70 | $12,623.01 |
| 5 | $12,623.01 | $63.12 | $601.69 | $12,021.32 |
| 6 | $12,021.32 | $60.11 | $604.70 | $11,416.61 |
| 7 | $11,416.61 | $57.08 | $607.73 | $10,808.89 |
| 8 | $10,808.89 | $54.04 | $610.76 | $10,198.12 |
| 9 | $10,198.12 | $50.99 | $613.82 | $9,584.30 |
| 10 | $9,584.30 | $47.92 | $616.89 | $8,967.42 |
| 11 | $8,967.42 | $44.84 | $619.97 | $8,347.44 |
| 12 | $8,347.44 | $41.74 | $623.07 | $7,724.37 |
| 24 | $661.50 | $3.31 | $661.50 | $0.00 |
