Economics
Amortization
Quick fact
In a typical 30-year mortgage, more than half of the first decade's payments go entirely toward interest, not the loan balance.
Why this is interesting
You've probably taken out a car loan or a mortgage—but did you know that even though you pay the same amount each month, the way that money is split between interest and principal changes over time?
Read the full explanation
Understanding Amortization
Imagine you borrow $100,000 to buy a house, agreeing to pay it back over 30 years with equal monthly payments. Each payment covers two things: interest (the cost of borrowing) and principal (the amount you originally borrowed). At the start, you owe a lot, so the interest portion is large. As you gradually pay down the principal, the interest shrinks, allowing more of each payment to reduce the balance. This process is called amortization. It's like filling a bathtub that has a small drain: you must add enough water each month to both cover the drain's outflow (interest) and slowly fill the tub (principal).
A deeper explanation
Amortization works through a mathematical formula that ensures each fixed payment exactly covers the interest due on the outstanding balance and reduces the principal by the remainder. The interest is calculated on the remaining principal each period, so early payments are interest-heavy. Over time, as principal drops, the interest portion declines, accelerating principal reduction. This creates an inverse relationship: the loan balance decreases slowly at first, then faster. The fundamental principle is that each payment is constant, but its allocation shifts according to a declining balance. Amortization matters because it makes large purchases manageable through predictable payments, but it also means borrowers pay significant total interest unless they make extra principal payments.