How Loan Amortization Actually Works
Where your early payments go, and why overpaying at the start saves the most interest.
An amortised loan is one where every payment is identical and each one splits differently between interest and principal. Understanding that split is the difference between accepting a repayment schedule and actively shortening it.
The payment formula
M = P × [ i(1+i)^n ] / [ (1+i)^n − 1 ]
P = principal i = monthly rate (APR / 12) n = number of paymentsA £250,000 mortgage at 5.5% over 25 years gives a monthly payment of about £1,535, of which £1,146 is interest in the first month and only £389 reduces the balance.
How the split moves over time
Interest each month is charged on the outstanding balance, so as the balance falls the interest share falls with it and the principal share grows. Progress is slow at first and accelerates sharply near the end.
| Year | Payment | Interest portion | Principal portion | Balance |
|---|---|---|---|---|
| 1 | £1,535 | £1,146 | £389 | £245,300 |
| 5 | £1,535 | £1,050 | £485 | £224,600 |
| 10 | £1,535 | £886 | £649 | £189,300 |
| 20 | £1,535 | £395 | £1,140 | £83,000 |
| 25 | £1,535 | £7 | £1,528 | £0 |
Why overpaying early is so effective
An overpayment reduces the principal, and every future interest charge is calculated on that smaller balance. The saving compounds for the remaining term, which is why the same £100 saves far more in year two than in year twenty.
| Extra per month | Term | Total interest | Interest saved |
|---|---|---|---|
| £0 | 25 yr 0 mo | £210,400 | — |
| £100 | 22 yr 8 mo | £186,900 | £23,500 |
| £250 | 19 yr 9 mo | £160,000 | £50,400 |
| £500 | 16 yr 1 mo | £128,300 | £82,100 |
Term length is the other lever
A longer term lowers the monthly payment and raises lifetime interest, sometimes dramatically. On the same £250,000 at 5.5%, a 30-year term costs about £261,000 in interest against £210,000 over 25 years — £51,000 for £115 a month of breathing room.
Things the standard schedule hides
- Fees rolled into the loan are financed at the same rate for the whole term.
- On a variable rate, the payment is recalculated at each change, so the schedule you were given is a projection, not a contract.
- Interest-only periods produce no amortisation at all — the balance at the end is exactly what you borrowed.
- Extending the term to lower a payment after several years restarts the interest-heavy portion of the curve.
Model any of these with the loan calculator, and check affordability against income using the debt-to-income calculator.
Frequently asked questions
Should overpayments reduce the term or the payment?
Reducing the term saves far more interest, because the balance falls faster. Reducing the payment improves monthly cash flow but leaves you paying interest for the original term.
Why is my balance barely moving in year one?
Interest is charged on the full outstanding balance, which is at its largest at the start. The principal share of each payment grows every month and overtakes interest partway through the term.
Does making biweekly payments help?
Paying half the monthly amount every two weeks produces 26 half-payments — one extra full payment a year — typically cutting several years from a 25-year term. The benefit comes from the extra payment, not the frequency.
What is negative amortisation?
A schedule where the payment is smaller than the interest accruing, so the balance grows. It appears in some deferred and interest-capitalising products and should be treated as a serious warning sign.