Question 1

What is amortization?

Accepted Answer

Amortization is the process of paying off a fixed-rate loan through equal periodic payments where each payment covers the interest accrued that period plus a chunk of principal. Because interest is calculated on the remaining balance, early payments are mostly interest and later payments are mostly principal. The schedule is designed so the balance hits zero exactly when the final scheduled payment lands. Standard US mortgages, auto loans, and federal student loans all use this structure - revolving products like credit cards and HELOCs in their draw phase do not.

Question 2

How does the monthly payment formula work?

Accepted Answer

The formula is M = P × r(1+r)^n / ((1+r)^n - 1), where P is the principal, r is the monthly interest rate (APR ÷ 12), and n is the total number of monthly payments. For a $400,000 mortgage at 7% APR over 30 years: r = 0.07/12 = 0.005833 and n = 360, yielding M ≈ $2,661.21. The formula comes from the present-value-of-annuity equation - it solves for the fixed payment that, when discounted at rate r, exactly equals the loan balance today. Change any of P, r, or n and the payment moves predictably.

Question 3

Why is most of my early payment going to interest?

Accepted Answer

Because interest each month equals your remaining balance times the monthly rate, and the balance is highest at the start. On a $400,000 7% mortgage, month 1 interest is $400,000 × 0.005833 ≈ $2,333, so only about $328 of the $2,661 payment reduces principal. As the balance drops, the interest portion shrinks and the principal portion grows. The split flips around year 15 on a 30-year loan. This back-loaded equity buildup is why selling within the first 5 to 7 years usually returns little after closing costs - you have barely dented the principal.

Question 4

How much can extra payments save me?

Accepted Answer

A lot, especially early in the loan. On a $400,000 30-year mortgage at 7%, adding $200 per month to principal pays the loan off in roughly 24 years instead of 30, saving about $100,000 in lifetime interest. Adding $500 per month cuts the term to about 20 years and saves around $185,000. The biweekly trick - paying half the monthly amount every two weeks - produces 13 full payments per year and shaves roughly 5 to 6 years off a 30-year loan. Earlier extra dollars save more because they kill the most future interest.

Question 5

Should I make extra payments or invest the difference?

Accepted Answer

Compare your after-tax mortgage rate to the realistic after-tax return on investing. At 7% with no deduction, paying down the loan gives a guaranteed 7% return - hard to beat after tax. But if you itemize and your loan is under the TCJA $750,000 cap, mortgage interest is deductible, dropping the effective rate to roughly 5 to 5.5% for a 24% bracket borrower. A long-horizon S&P 500 index fund has historically returned about 7% real after tax, so investing can edge out paydown - but with volatility risk. Many people split the difference: pay extra when rates exceed 6 to 7%, invest when below.

Year	Principal	Interest	End Balance
1	$4,063	$27,871	$395,937
2	$4,357	$27,578	$391,580
3	$4,672	$27,263	$386,908
4	$5,010	$26,925	$381,898
5	$5,372	$26,563	$376,526
6	$5,760	$26,174	$370,766
7	$6,177	$25,758	$364,590
8	$6,623	$25,311	$357,967
9	$7,102	$24,833	$350,865
10	$7,615	$24,319	$343,250

Year	Principal	Interest	End Balance
1	$4,063	$27,871	$395,937
2	$4,357	$27,578	$391,580
3	$4,672	$27,263	$386,908
4	$5,010	$26,925	$381,898
5	$5,372	$26,563	$376,526
6	$5,760	$26,174	$370,766
7	$6,177	$25,758	$364,590
8	$6,623	$25,311	$357,967
9	$7,102	$24,833	$350,865
10	$7,615	$24,319	$343,250

Amortization Calculator (Loan Schedule)