Understanding the cost of borrowing: What is amortization and why it matters

March 12, 2020

Have you ever wondered how much you spend on interest? Thanks to an accounting concept known as amortization, finding out may be easier than you realize.

 

Mortgages, auto and personal loans are some of the most common amortizing loans. They can all be paid down over a set period of time. Even better, they can be broken down into a simple payment schedule.

 

What is amortization?

Amortization describes a subtle change in your loan payments over time. The cost of your monthly payments stays consistent. However, the monthly cost of interest gradually decreases from month to month. This happens because interest rates are calculated based on your loan balance, not your monthly payment. As you pay off your loan, the balance steadily decreases along with the monthly cost of interest.

Spending less on interest leaves you with more money to cover the true cost of your loan – the principal. With every passing payment, a smaller portion of your total payment pays for interest, while a larger portion pays for the principal. This inverse relationship is amortization at work.

Let’s consider a $300,000 mortgage paid over 30 years. At an interest rate of 5%, your monthly payments will be $1,610.46. For the sake of simplicity, tax and insurance costs are not included in these calculations.

Here’s how the numbers play out over ten months:

Month

Starting payment

Payment

Principal

Monthly interest cost

Final balance

Cumulative interest

1

$300,000.00

$1,610.46

$360.46

$1,250.00

$299,639.54

$1,250.00

2

$299,639.54

$1,610.46

$361.97

$1,248.50

$299,277.57

$2,498.50

3

$299,277.57

$1,610.46

$363.48

$1,246.99

$298,914.09

$3,745.49

4

$298,914.09

$1,610.46

$364.99

$1,245.48

$298,549.10

$4,990.96

5

$298,549.10

$1,610.46

$366.51

$1,243.95

$298,182.59

$6,234.92

6

$298,182.59

$1,610.46

$368.04

$1,242.43

$297,814.56

$7,477.35

7

$297,814.56

$1,610.46

$369.57

$1,240.89

$297,444.99

$8,718.24

8

$297,444.99

$1,610.46

$371.11

$1,239.35

$297,073.87

$9,957.59

9

$297,073.87

$1,610.46

$372.66

$1,237.81

$296,701.22

$11,195.40

10

$296,701.22

$1,610.46

$374.21

$1,236.26

$296,327.01

$12,431.66

Month

1

Starting payment

$300,000.00

Payment

$1,610.46

Principal

$360.46

Monthly interest cost

$1,250.00

Final balance

$299,639.54

Cumulative interest

$1,250.00

Month

2

Starting payment

$299,639.54

Payment

$1,610.46

Principal

$361.97

Monthly interest cost

$1,248.50

Final balance

$299,277.57

Cumulative interest

$2,498.50

Month

3

Starting payment

$299,277.57

Payment

$1,610.46

Principal

$363.48

Monthly interest cost

$1,246.99

Final balance

$298,914.09

Cumulative interest

$3,745.49

Month

4

Starting payment

$298,914.09

Payment

$1,610.46

Principal

$364.99

Monthly interest cost

$1,245.48

Final balance

$298,549.10

Cumulative interest

$4,990.96

Month

5

Starting payment

$298,549.10

Payment

$1,610.46

Principal

$366.51

Monthly interest cost

$1,243.95

Final balance

$298,182.59

Cumulative interest

$6,234.92

Month

6

Starting payment

$298,182.59

Payment

$1,610.46

Principal

$368.04

Monthly interest cost

$1,242.43

Final balance

$297,814.56

Cumulative interest

$7,477.35

Month

7

Starting payment

$297,814.56

Payment

$1,610.46

Principal

$369.57

Monthly interest cost

$1,240.89

Final balance

$297,444.99

Cumulative interest

$8,718.24

Month

8

Starting payment

$297,444.99

Payment

$1,610.46

Principal

$371.11

Monthly interest cost

$1,239.35

Final balance

$297,073.87

Cumulative interest

$9,957.59

Month

9

Starting payment

$297,073.87

Payment

$1,610.46

Principal

$372.66

Monthly interest cost

$1,237.81

Final balance

$296,701.22

Cumulative interest

$11,195.40

Month

10

Starting payment

$296,701.22

Payment

$1,610.46

Principal

$374.21

Monthly interest cost

$1,236.26

Final balance

$296,327.01

Cumulative interest

$12,431.66

Notice how the principal increases with every payment, while the monthly cost of interest decreases. Also, notice how much of your total monthly payment goes toward interest each month. It’s a lot! For most mortgages, interest may make up the bulk of your payments for several years.

 

Why does amortization matter?

Amortization shows us the true cost of borrowing. With an amortization schedule like the one shown above, it’s easy to see exactly how much you owe in interest. A quick look at your cumulative cost of interest can be eye-opening.

Amortization also calls attention to the benefits of paying off debt early. When you pay more than you owe each month, you can quickly lower your loan balance, and therefore decrease your total cost of interest.

Consider our previous example of a $300,000 mortgage at 5% interest. If you pay the minimum monthly payment for 30 years, your cumulative interest will total $279,767. Here’s what your amortization schedule will show for the final months of your mortgage:

Month

Starting balance

Payment

Principal

Monthly interest cost

Final balance

Cumulative interest

357

$6,375.31

$1,610.46

$1,583.90

$26.56

$4,791.41

$279,727.37

358

$4,791.41

$1,610.46

$1,590.50

$19.96

$3,200.91

$279,747.33

359

$3,200.91

$1,610.46

$1,597.13

$13.34

$1,603.78

$279,760.67

360

$1,603.78

$1,603.78

$1,597.10

$6.68

$0.0

$279,767.35

Month

357

Starting balance

$6,375.31

Payment

$1,610.46

Principal

$1,583.90

Monthly interest cost

$26.56

Final balance

$4,791.41

Cumulative interest

$279,727.37

Month

358

Starting balance

$4,791.41

Payment

$1,610.46

Principal

$1,590.50

Monthly interest cost

$19.96

Final balance

$3,200.91

Cumulative interest

$279,747.33

Month

359

Starting balance

$3,200.91

Payment

$1,610.46

Principal

$1,597.13

Monthly interest cost

$13.34

Final balance

$1,603.78

Cumulative interest

$279,760.67

Month

360

Starting balance

$1,603.78

Payment

$1,603.78

Principal

$1,597.10

Monthly interest cost

$6.68

Final balance

$0.0

Cumulative interest

$279,767.35

But what happens if you pay an extra $50 every month? Let’s adjust our amortization schedule to find out.

Month

Starting balance

Monthly payment

Extra payment

Principal

Monthly interest cost

Final balance

Cumulative interest

334

$5,125.55

$1,610.46

$50.00

$1,639.11

$21.36

$3,486.44

$258,081.71

335

$3,486.44

$1,610.46

$50.00

$1,645.94

$14.53

$1,840.50

$258,096.23

336

$1,840.50

$1,610.46

$50.00

$1,652.80

$7.67

$187.71

$258,103.90

337

$187.71

$187.71

$0.0

$186.92

$0.78

$0.0

$258,104.68

Month

334

Starting balance

$5,125.55

Monthly payment

$1,610.46

Extra payment

$50.00

Principal

$1,639.11

Monthly interest cost

$21.36

Final balance

$3,486.44

Cumulative interest

$258,081.71

Month

335

Starting balance

$3,486.44

Monthly payment

$1,610.46

Extra payment

$50.00

Principal

$1,645.94

Monthly interest cost

$14.53

Final balance

$1,840.50

Cumulative interest

$258,096.23

Month

336

Starting balance

$1,840.50

Monthly payment

$1,610.46

Extra payment

$50.00

Principal

$1,652.80

Monthly interest cost

$7.67

Final balance

$187.71

Cumulative interest

$258,103.90

Month

337

Starting balance

$187.71

Monthly payment

$187.71

Extra payment

$0.0

Principal

$186.92

Monthly interest cost

$0.78

Final balance

$0.0

Cumulative interest

$258,104.68

Not only does your loan term shorten by 23 months, you save $21,662.67 in interest. That’s a lot of hard-earned money!

 

Amortization schedules are decision-making tools

Amortization schedules are a valuable source of knowledge. With a few easy calculations, you can see your principal, monthly interest and cumulative interest at year one, two, 10 or 20. Plus, an amortization schedule can calculate how much you save by paying over the monthly minimum.

If you’re in the market for a loan, consider using a schedule to compare borrowing options. Doing so will help you understand what you’re signing up for. For example, you may be tempted to choose a loan with low monthly payments and higher interest rates. This often seems like the more affordable option, but in reality, the cumulative cost of interest may be quite high.

 

Create a schedule for your loan

Creating an amortization schedule is as simple as plugging in a few numbers. Get started with Excel’s built-in amortization templates. Or, just browse online where you’ll find a variety of calculators to help you see numbers more specific to your situation.

 

If you have questions about amortization, we’re here to help. Make an appointment with us today.

Related content

Evaluating interest rate risk creating risk management strategy

At your service: outsourcing loan agency work

For today's homebuyers, time and money are everything

How I did it: Bought a home without a 20 percent down payment

Money Moments: Tips for selling your home

Overcoming high interest rates: Getting your homeownership goals back on track

Should you buy a house that’s still under construction?

Everything you need to know about consolidating debts

How having savings gives you peace of mind

Avoiding the pitfalls of warehouse lending

What you should know about buying a car

Is it the right time to refinance your mortgage?

6 questions to ask before buying a new home

What is a home equity line of credit (HELOC) and what can it be used for?

How to use credit cards wisely for a vacation budget

Your financial aid guide: What are your options?

Maximizing your infrastructure finance project with a full suite trustee and agent

8 steps to take before you buy a home

What is refinancing a mortgage?

Are professional movers worth the cost?

What to know when buying a home with your significant other

Mortgage basics: 3 key steps in the homebuying process

Mortgage basics: Buying or renting – What’s right for you?

Mortgage basics: Prequalification or pre-approval – What do I need?

How you can take advantage of low mortgage rates

Mortgage basics: Finding the right home loan for you

Mortgage basics: What is refinancing, and is it right for you?

5 financial goals for the new year

What’s your financial IQ? Game-night edition

A checklist for starting a mobility program review

Common unexpected expenses and three ways to pay for them

How to build and maintain a solid credit history and score

7 steps to keep your personal and business finances separate

What you need to know before buying a new or used car

An investor’s guide to marketplace lending

What is a CLO?

Beyond Mars, AeroVironment’s earthly expansion fueled by U.S. Bank

ABL mythbusters: The truth about asset-based lending

Collateral options for ABL: What’s eligible, what’s not?

Can ABL options fuel your business — and keep it running?

Luxembourg's thriving private debt market

Top 3 considerations when selecting an IPA partner

Evaluating interest rate risk creating risk management strategy

Tech lifecycle refresh: A tale of two philosophies

Changes in credit reporting and what it means for homebuyers

What’s the difference between Fannie Mae and Freddie Mac?

Why other lenders may be reaching out to your employees

High-cost housing and down payment options in relocation

4 benefits of independent loan agents

Middle-market direct lending: Obstacles and opportunities

Crypto + Relo: Mobility industry impacts

For today's relocating home buyers, time and money are everything

How to fund your business without using 401(k) savings

Costs to consider when starting a business

How jumbo loans can help home buyers and your builder business

When to consider switching banks for your business

5 tips to help you land a small business loan

Good debt vs. bad debt: Know the difference

Student checklist: Preparing for college

The A to Z’s of college loan terms

Co-signing 101: Applying for a loan with co-borrower

Practical money skills and financial tips for college students

How I did it: Paid off student loans

Pros and cons of a personal line credit

3 tips for saving money when moving to a new home

5 myths about emergency funds

Tips to overcome three common savings hurdles

Personal loans first-timer's guide: 7 questions to ask

Things to know about the Servicemembers Civil Relief Act

5 tips to use your credit card wisely and steer clear of debt

Is a home equity loan for college the right choice for your student

Parent checklist: Preparing for college

How to apply for federal student aid through the FAFSA

What to consider before taking out a student loan

Are you ready to restart your federal student loan payments?

Consolidating debts: Pros and cons to keep in mind

5 tips to use your credit card wisely and steer clear of debt

How to use debt to build wealth

What’s a subordination agreement, and why does it matter?

Understanding the true cost of borrowing: What is amortization, and why does it matter?

Know your debt-to-income ratio

How to pay off credit card debt

Your quick guide to loans and obtaining credit

Dear Money Mentor: What is cash-out refinancing and is it right for you?

Crypto + Homebuying: Impacts on the real estate market

How I did it: Bought my dream home using equity

Saving for a down payment: Where should I keep my money?

What are conforming loan limits and why are they increasing

The lowdown on 6 myths about buying a home

Money Moments: How to finance a home addition

First-time homebuyer’s guide to getting a mortgage

Dear Money Mentor: When should I refinance a mortgage?

What is an escrow account? Do I have one?

These small home improvement projects offer big returns on investment

Should you get a home equity loan or a home equity line of credit?

Mortgage basics: What’s the difference between interest rate and annual percentage rate?

Is a home equity line of credit (HELOC) right for you?

How to use your home equity to finance home improvements

How do I prequalify for a mortgage?

Can you take advantage of the dead equity in your home?

4 questions to ask before you buy an investment property

10 uses for a home equity loan

6 essential credit report terms to know

Test your loan savvy

U.S. Bank asks: What do you know about credit?

What types of credit scores qualify for a mortgage?

How to improve your credit score

Take the stress out of buying your teen a car

Questions to ask before buying a car

How to choose the best car loan for you

Start of disclosure content

Loan approval is subject to credit approval and program guidelines. Not all loan programs are available in all states for all loan amounts. Interest rate and program terms are subject to change without notice. Mortgage, Home Equity and Credit products are offered through U.S. Bank National Association. Deposit products are offered through U.S. Bank National Association. Member FDIC.