Understanding Amortization: How Loan Payments and Interest Actually Work

Amortization is the process of spreading out a loan into a series of equal periodic payments. Although the total monthly installment remains constant over the life of a fixed-rate loan, the internal division between interest and principal shifts dramatically over time.

Fixed monthly mortgage and loan payments are computed via: $$PMT = P \times \frac{r(1 + r)^n}{(1 + r)^n - 1}$$ Where $P$ is principal borrowed, $r$ is monthly interest rate (annual APR ÷ 12), and $n$ is total number of monthly payments.

Interest is charged each month on the remaining outstanding balance. In the first few years of a 30-year mortgage, the outstanding balance is at its highest, meaning that 70% or more of each monthly check covers interest charges rather than building home equity.