What is loan amortization?
Amortization is the process of paying off a loan with regular, equal payments over a set period. Each payment covers both the interest accrued since the last payment and a portion of the principal (the original amount borrowed).
The key thing to understand is that the split between interest and principal changes with every payment. At the beginning of the loan, most of your payment goes to interest. As you pay down the principal, the interest portion decreases and more of your payment goes to principal.
How the monthly payment is calculated
The monthly payment on an amortizing loan is calculated using this formula:
M = P × [r(1+r)^n] ÷ [(1+r)^n − 1]
Where: M = monthly payment, P = principal (loan amount), r = monthly interest rate (annual rate ÷ 12), n = total number of payments (years × 12).
The formula ensures that the payment is high enough to cover all the interest that will accrue over the life of the loan, plus pay off the entire principal by the end of the term. The payment stays the same every month, but the composition changes.
How to read an amortization schedule
An amortization schedule is a table that shows every payment over the life of the loan, broken down into interest, principal, and remaining balance. Here is what the first few months of a $100,000 loan at 6% over 10 years looks like:
| Month | Payment | Interest | Principal | Balance |
|---|---|---|---|---|
| 1 | $1,110.21 | $500.00 | $610.21 | $99,389.79 |
| 2 | $1,110.21 | $496.95 | $613.26 | $98,776.53 |
| 3 | $1,110.21 | $493.88 | $616.33 | $98,160.20 |
| 6 | $1,110.21 | $484.56 | $625.65 | $96,276.04 |
| 12 | $1,110.21 | $465.48 | $644.73 | $92,746.38 |
| 60 | $1,110.21 | $301.52 | $808.69 | $59,744.12 |
| 120 | $1,110.21 | $5.52 | $1,104.69 | $0.00 |
Notice that in month 1, 45% of the payment goes to interest. By month 60 (halfway through), only 27% goes to interest. By the final month, less than 1% goes to interest. This is the amortization curve in action.
Why this matters for student loans
For nurses with student loans, understanding amortization is critical because:
- Income-driven repayment plans can lead to negative amortization. If your monthly payment under an IDR plan is less than the interest accruing each month, your balance actually grows over time. This is called negative amortization, and it is why some borrowers end up owing more than they originally borrowed despite making payments for years.
- Refinancing to a lower rate saves more than you think. Because interest is calculated on the remaining balance every month, even a 1% rate reduction can save you thousands over the life of the loan. On $100,000 over 10 years, dropping from 7% to 6% saves $6,200 in total interest.
- Extra payments go entirely to principal. When you make an extra payment beyond your required monthly amount, the entire extra amount goes to principal (assuming you specify it as a principal-only payment). This reduces your balance faster, which means less interest accrues in future months.
How extra payments save you money
Let us use the same $100,000 loan at 6% over 10 years. The standard payment is $1,110/month, and total interest is $33,225.
| Extra Payment/Month | Total Interest | Interest Saved | Months Saved |
|---|---|---|---|
| $0 (standard) | $33,225 | $0 | 0 |
| $50 | $30,380 | $2,845 | 7 |
| $100 | $27,960 | $5,265 | 13 |
| $200 | $24,050 | $9,175 | 23 |
| $500 | $16,920 | $16,305 | 41 |
An extra $100/month—less than the cost of a daily coffee habit—saves you over $5,000 and gets you out of debt over a year early. This is one of the highest-return "investments" you can make, because the return is guaranteed and equal to your loan's interest rate.
Amortization vs simple interest
Most student loans, mortgages, and car loans are amortizing. But some loans—particularly credit cards and some personal loans—use simple interest or daily interest calculations. With simple interest, interest is calculated on the average daily balance, and there is no fixed payoff date if you only make minimum payments. This is why credit card debt can take decades to pay off if you only make minimum payments.