Amortized Loan: What It Is, How It Works, Loan Types, and Example

By 

Julia Kagan

Updated July 18, 2024

Reviewed by 

Thomas Brock

Fact checked by 

Katrina Munichiello

What Is an Amortized Loan?

An amortized loan is a type of loan with scheduled, periodic payments that are applied to both the loan’s principal amount and accrued interest.

An amortized loan payment first pays off the relevant interest expense for the period, after which the remainder reduces the principal amount. Common amortized loans include auto loans, fixed-rate mortgages, home equity loans, and personal loans from a bank for small projects or debt consolidation.

Key Takeaways

• An amortized loan reflects the payment schedule that comprises periodic, fixed payments in which a portion goes to interest and principal. 
• An amortized loan payment first pays off the interest for the period, with the remaining amount reducing the principal.
• As a borrower makes payments over time, the interest portion of the payments for an amortization loan decreases, while the principal increases.

How an Amortized Loan Works

With an amortized loan, a portion of each fixed monthly payment goes to paying the monthly interest and reducing the principal—the original borrowed amount. The interest on an amortized loan is calculated based on the most recent ending balance of the loan.

Principal and Interest

As a borrower makes payments over time, the principal decreases, reducing the balance on which the interest is calculated. As a result, the interest amount owed decreases over time.

As the interest portion of an amortized loan decreases, the principal portion of the payment increases. Therefore, interest and principal have an inverse relationship within the payments over the life of the amortized loan.1

Calculating an Amortized Loan

An amortized loan is the result of a series of calculations. First, the loan’s current balance is multiplied by the interest rate attributable to the current period to find the interest due for the period. (Annual interest rates may be divided by 12 to find a monthly rate.)

Subtracting the interest due for the period from the total monthly payment results in the dollar amount of principal paid in the period.

The principal amount paid in the period is applied to the outstanding loan balance. Therefore, the current loan balance, minus the principal amount paid in the period, results in the new outstanding loan balance, which is used to calculate the interest for the next period.

Warning

Mortgage lending discrimination is illegal. If you think you’ve been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report, either to the Consumer Financial Protection Bureau or the U.S. Department of Housing and Urban Development (HUD).2

Amortized Loans vs. Balloon Loans vs. Revolving Debt (Credit Cards)

While amortized loans, balloon loans, and revolving debt—specifically credit cards—share similarities, they have important distinctions you should be aware of before signing up.

Amortized Loans

Typically, amortized loans get paid off over an extended period of time, with equal amounts paid for each payment period. Amortized loans have an amortization schedule in which a portion of each fixed monthly payment comprises the monthly interest and the principal loan balance.

However, borrowers can make an extra payment to reduce the principal owed, but the remaining monthly payments will remain unchanged. In other words, paying extra on an amortized loan reduces the loan balance, shortens the loan term and saves you interest, but it does not change the monthly payment.

Balloon Loans

Balloon loans usually have a relatively short term, and only a portion of the loan’s principal balance is amortized over that term. At the end of the term, the remaining balance is due as a final repayment, which is generally large—at least double the amount of previous payments.3

Revolving Debt (Credit Cards) 

Credit cards are the most well-known type of revolving debt, which allows you to borrow up to a preset credit limit. In other words, you can no longer borrow from a revolving credit line if you have reached your credit limit.

However, if you pay down a portion of the outstanding balance on a revolving credit, your credit availability increases by that amount. As a result, a revolving credit allows you to pay off and borrow again up to your credit limit indefinitely.

Credit cards work differently from amortized loans because they don’t have set payment amounts or a fixed loan amount. Credit card minimum monthly payments typically do not include any principal, meaning the payment only covers the monthly interest cost.4

Important

Amortized loans apply each payment to both interest and principal, initially paying more interest than principal until eventually that ratio is reversed.

Example of an Amortization Loan Table

An amortization table displays the calculations of an amortized loan, listing relevant balances and dollar amounts for each period. In the example below, each row in the table represents one period.

The columns include:

• The payment date
• Principal portion of the payment
• Interest portion
• Total interest paid to date
• Ending outstanding balance

The following table excerpt is for the first year of a 30-year fixed-rate mortgage for $165,000 with an annual interest rate of 4.5%

Tip

Remember, applying an extra principal payment to an amortized loan, like a fixed-rate mortgage or auto loan, does not reduce the amount of your future monthly payments. The monthly payments remain fixed throughout the life of amortized loans unless you modify the loan terms or refinance the loan.

What Is the Simple Meaning of Amortized?

Amortized typically refers to a method of paying down a loan, such as a fixed-rate mortgage, by making fixed, periodic payments comprised of a portion going towards the monthly interest and the remaining to the principal loan balance.

Can I Pay Off an Amortized Loan Early?

Yes. To pay off an amortized loan early, you can make payments more frequently or make principal-only payments. Since the interest is charged on the principal, making extra payments lowers the principal amount that can accrue interest. Before making extra principal payments, review your loan agreement to see if your lender charges an early payoff penalty fee.

How Can I See How Much of My Payment Is Interest?

Your lender should provide an amortization schedule showing how much of each payment will comprise i