Amortization

Key Takeaways

• On an amortized loan every scheduled payment first covers the interest that accrued on the outstanding balance, and only the remainder reduces principal.
• Early payments on a 30 year loan are mostly interest, and the principal share grows with every payment because the balance keeps shrinking.
• A fully amortized loan reaches a zero balance on the last scheduled payment, with no lump sum left owing.
• Negative amortization is the opposite case: the payment is smaller than the interest due, so the shortfall is added to the balance and the debt grows.

What It Means

Amortization is the process of paying a loan down to zero through regular scheduled payments across a set term. Each payment does two jobs. First it covers the interest that has accrued on the outstanding balance since the last payment. Whatever is left over reduces the principal. Because the balance shrinks after every payment, the interest portion of the next payment is smaller and the principal portion is larger.

That is why an amortization schedule looks so lopsided at the start. On a 30 year loan the first several years are nearly all interest, and the crossover point where the principal share passes the interest share arrives much later than most borrowers expect. The payment amount itself does not move on a Fixed Rate Mortgage. Only the split inside it moves.

A loan is fully amortized when the scheduled payments retire the whole balance by the final due date. If the schedule leaves a lump sum owing at the end, that lump sum is a Balloon Payment. If a payment is too small to cover the interest, the shortfall is added to what is owed and the loan is in Negative Amortization.

How It Works in Washington

The arithmetic of amortization is the same in every state, but what happens when the payments stop is state law. In Washington, an amortized home loan is almost always secured by a Deed Of Trust, which RCW 61.24.020 describes as a deed conveying real property to a trustee in trust to secure the performance of an obligation. Missing the scheduled installments is what puts that obligation in default and starts the trustee's sale process in RCW 61.24.

The schedule matters again on the way back out. Under RCW 61.24.090 a Washington borrower can stop a trustee's sale at any time before the eleventh day ahead of the sale date by curing the default, which means paying the entire amount then due plus the trustee's costs and fees, but not the portion of principal that would not yet be due had there been no default. In plain terms, a borrower who has missed four monthly installments reinstates by paying those four installments and costs, not the whole remaining balance. If the sale does go through, RCW 61.24.100 generally bars the lender from taking a deficiency judgment against the borrower afterward.

Example

Chen borrows $300,000 at 6 percent fixed interest for 30 years to buy a house in Everett. The scheduled principal and interest payment is $1,798.65 a month, and it never changes.

Payment one: interest is $300,000 times 6 percent divided by 12, which is $1,500.00. That leaves $298.65 to reduce principal, so the balance drops to $299,701.35.

Payment two: interest is now $299,701.35 times 0.005, which is $1,498.51. Principal gets $300.14 and the balance falls to $299,401.21.

The payment is identical both months, but $1.49 of it moved from the interest column to the principal column, and it keeps moving that way every month. Across all 360 payments Chen pays $647,514 in total, of which $347,514 is interest. That gap between $300,000 borrowed and $647,514 repaid is what an amortization schedule is really showing a student.

Common Mistakes and Exam Traps

• On a level payment amortized loan the payment amount stays the same and only the interest and principal split changes, so an answer saying the payment shrinks each month describes a different loan.
• Interest is charged on the balance that was outstanding, so the interest in any payment is figured on last month's balance, never on the original loan amount.
• Negative amortization is not slow amortization; the balance rises instead, because the payment does not cover the interest due.
• A partially amortized loan still ends in a balloon payment, so the word amortized alone does not promise a zero balance at the end of the term.