Understanding Amortization: A Guide to Managing Your Debt
Definition
Amortization is the gradual reduction of a debt over a given period.
Why It's Important
This is how you can figure out how much you are really spending over the course of a loan. It also shows how much of your payment is actually going towards principal and what’s being wasted on interest. Honestly, it’s best to just use a calculator vs trying to calculate everything by hand.
An amortization calculator will amortize (show the reduction) your debt (such as a mortgage) and display your payment breakdown of interest paid, principal paid, and loan balance over the life of the loan.
It comes as a surprise to some that most of your initial payments on a loan are used to pay interest. For example, in a 30-year mortgage over 83% of your payments are used to pay down interest in the first year, while only 3% of your payments are used to pay down interest in the final year. This is the primary reason why little equity is built in the first few years of a mortgage and it’s best to hold a house long term.
