How mortgage amortization works

The payment formula

A fixed-rate mortgage payment is set so that, paid every month for the whole term, it covers each month's interest and brings the balance to exactly zero with the last payment. The standard formula, where P is the loan amount, r is the monthly rate (the annual rate divided by 12) and n is the number of payments:

Payment = P × r(1 + r)ⁿ ÷ ((1 + r)ⁿ − 1)

For our example, a $360,000 home (close to the U.S. median value) bought with 20% down, P is $288,000, r is 7.24% ÷ 12 and n is 360. The result is $1,962.71 a month for principal and interest. With 20% down there is no private mortgage insurance, which keeps the schedule clean; the PMI guide shows how a smaller down payment adds it.

Why early payments are mostly interest

Each month's interest is simply the rate times what you still owe. In month one that is $288,000 × 7.24% ÷ 12 = $1,737.60, leaving only $225.11 of the payment to reduce the balance. Next month the balance is a little lower, so the interest is a little lower and the principal a little higher. The shift is slow at first and speeds up as the balance falls:

$288,000 30-year fixed loan at 7.24%, the latest Freddie Mac average. Interest and principal are the amounts paid during that year; the balance is at the end of it.

In the first year you pay $20,760 of interest and only $2,793 of principal. After five years you have paid $101,546 in interest but cut the balance by just $16,217. Principal first exceeds interest in payment 246 ($982.71 against $980.00), and half the loan is not repaid until payment 263, 21 years 11 months in. All told, $418,582 of interest on a $288,000 loan: you repay $706,582, about $1.45 of interest for every dollar borrowed.

This is also why equity builds slowly in the early years, and why selling or refinancing a few years in leaves most of the original balance still owed.

30-year vs 15-year at today's rates

A 15-year loan has a higher payment, but it usually carries a lower rate and pays the balance down from the start, so far less interest builds up:

$288,000 loan. Rates are the latest Freddie Mac weekly averages: 7.24% for 30 years and 6.60% for 15 years.

The 15-year loan costs $562 more a month and saves $252,145 of interest. Its principal overtakes interest in payment 55 instead of 246. The 30-year payment is easier to carry and leaves room to pay extra when you can, which the next section shows.

What extra payments save

Money paid on top of the regular payment goes straight to principal (federal rules allow a prepayment penalty only on certain fixed-rate loans, and only in the first three years), so it never earns interest for the lender again. On the same 30-year loan at 7.24%, with extra payments starting from the first month:

One extra payment a year is a full $1,963 payment made with the 12th payment of each year; biweekly half-payments add up to the same 13 payments a year. The regular payment stays $1,963.

$250 a month saves $140,666 and takes 8 years 8 months off the loan. One extra payment a year works out to about $164 a month and lands between the two. Adding a twelfth of the payment to every monthly payment instead gets you there slightly sooner (6 years 5 months early, $105,874 saved), because the money starts cutting the balance earlier in each year. The mortgage calculator shows the same savings alongside tax and insurance.

Recasting and refinancing are different

If you pay a lump sum, your regular payment normally stays the same and the loan just ends sooner. A recast asks the servicer to re-amortize the lower balance over the months you have left, keeping your rate and term, so the payment drops instead. Not every lender or loan type offers it, and there is usually a fee. In our example, paying $20,000 after 5 years leaves $251,783; a recast cuts the payment by $144 to $1,818 and saves $23,331 of interest. Keeping the old payment instead saves $83,585 and ends the loan 4 years 4 months early.

Refinancing replaces the loan with a new one at a new rate and term, with closing costs, and restarts amortization from the beginning, so the early, interest-heavy years come back. Whether it pays depends on the break-even month; see is refinancing worth it? and the refinance calculator.

What amortization does not include

Your monthly bill is often more than principal and interest. If your lender collects property tax and homeowners insurance through an escrow account, those amounts are added on top and paid out to the county and insurer; they do not reduce the loan and can change every year. At the national averages of 0.89% of value for tax and $4.29 per $1,000 for insurance, our example adds $267 and $129 a month, for a total of about $2,358.

Some loans do not amortize normally at all. With an interest-only loan, early payments cover just the interest, $1,738 a month on our example, so the balance does not fall; when that period ends, the payment jumps to repay the full balance over the shorter remaining term. With negative amortization, the payment is less than the interest, the shortfall is added to the balance, and you owe more over time even while paying. Federal qualified mortgage rules exclude both features, so they are uncommon today, but they still exist.