What Is Amortization? How Amortization Works in Real Estate

In real estate, amortization is a mathematical process that dictates how much of a homeowner’s monthly mortgage payment goes toward the interest and principal of the loan. With amortization, payments made near the beginning of the loan contribute primarily toward interest, while later payments go toward the principal loan amount. The amortization process generally operates along a curve rather than a straight line (especially fixed-rate loans). Borrowers typically prefer to be further along the amortization curve because it means that they’re paying off more of the loan principal and making more progress in paying off their loan. Additionally, borrowers can pay off their loans sooner by making extra payments.

Many borrowers use estimates—like an amortization schedule, balance sheet, amortization calculator, or amortization table—to predict the curve of their loan amortization, determine how long it will take to pay off their interest and principal, and ensure that the loan amortizes. Paying a loan off on schedule with the loan term is known as an “amortized loan” or “amortizing loan.”

In property law, amortization can also refer to the expense of an intangible asset over the asset’s useful life; examples of intangible assets include copyrights, goodwill, or patents. Within the property law framework, amortization operates similarly to the way depreciation works with tangible assets and depletion works with natural resources.

Amortization works in a few steps:

1. 1. A borrower takes out a loan. When a borrower takes out a loan (like a car loan, home loan, or personal loan) from a lender, the loan will include two variables: the principal balance and the total interest due. The principal refers to the original loan amount, while the total interest is an extra percentage paid on top of the principal, determined by the loan’s interest rate. The borrower must pay off both the principal payments and interest charges over the life of the loan to ultimately pay it off.
2. 2. The borrower begins making periodic payments. Once the lender sets the loan up, the borrower will start the loan repayment process by making regular payments (usually monthly installments, like a monthly mortgage or auto loan payment). In early loan payments, because the loan balance is large, a large proportion of each payment goes to interest payments rather than the principal amount—this is known as the early stages of the amortization curve.
3. 3. The borrower continues to make payments. As the loan matures, the outstanding balance shrinks. Thus, the ratio of interest-to-principal will shift until each total payment amount goes more toward principal and less toward interest—this is known as the later stages of the amortizing process.
4. 4. The borrower pays off the loan. After a set period of time and a certain number of monthly payments (depending on the loan and rate), the borrower will primarily pay the principal until they finish paying off the loan. However, a few things can reset the mortgage amortization process—the most common is refinancing a mortgage loan, which restarts the amortization curve. After the refinance, the borrower will start the new loan paying more toward interest than principal.

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