How mortgage amortization works

A fixed payment, a changing split

A fixed-rate mortgage has the same principal-and-interest payment every month. What changes is how that payment is divided. Each month the lender charges interest on the balance you still owe; whatever is left of the payment reduces the balance.

At the start, the balance is at its largest, so interest takes most of the payment. On a 30-year loan at 6 %, roughly five-sixths of the first payment is interest. As the balance falls, interest shrinks and more of each payment goes to principal, which is why equity builds slowly at first and quickly later.

Why the payment is what it is

The payment is calculated so the balance reaches exactly zero after the final scheduled payment. The standard formula is M = L × i ÷ (1 − (1 + i)^−n), where L is the loan amount, i is the monthly rate and n is the number of payments. Lenders round interest to the cent each month, so the final payment is usually a few cents different from the others.

What extra payments do

Any amount you pay above the scheduled payment normally goes straight to principal. Because next month’s interest is charged on a smaller balance, the saving compounds: every extra unit you pay early avoids interest in every remaining month.

That is why small regular extra payments can shorten a long mortgage by years. Paying half the monthly amount every two weeks has a similar effect, because 26 half-payments equal 13 monthly payments a year. The mortgage prepayment comparison calculator shows how monthly, yearly and one-off prepayments compare for the same loan.

Before prepaying, check whether your loan has prepayment penalties, and make sure you have an emergency fund — money paid into a mortgage is not easy to get back out.