Every loan payment you make is split between two things: paying down the debt you owe, and paying the lender for the privilege of borrowing. Amortisation is the process that determines exactly how that split works — and why your early payments feel like they barely touch the balance.
What Is Loan Amortisation?
Amortisation (American spelling: amortization) is the gradual repayment of a loan through scheduled payments over time. Each payment is the same total amount, but the proportion going to interest versus principal shifts with every payment.
At the start of the loan, most of your payment covers interest. By the end, almost all of it reduces the principal. This isn't a trick — it's simple arithmetic that follows directly from how interest is calculated.
The Core Formula
Monthly payment for a fixed-rate loan:
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)
Example: £200,000 mortgage at 4.5% over 25 years
- r = 4.5% / 12 = 0.375% = 0.00375
- n = 25 × 12 = 300 payments
- M = 200,000 × [0.00375 × (1.00375)^300] / [(1.00375)^300 − 1]
- M = £1,111.85 per month
How Each Payment Splits
Month 1:
- Interest = £200,000 × 0.375% = £750.00
- Principal = £1,111.85 − £750.00 = £361.85
- Remaining balance = £199,638.15
Month 2:
- Interest = £199,638.15 × 0.375% = £748.64
- Principal = £1,111.85 − £748.64 = £363.21
- Remaining balance = £199,274.94
Notice: as the balance falls, the interest charge falls with it — so slightly more of each payment chips away at principal. This is the compounding effect working in reverse, slowly in your favour.
The Amortisation Schedule
A full amortisation schedule shows every payment over the loan's life:
| Payment | Total paid | Interest | Principal | Balance | |---------|-----------|----------|-----------|---------| | 1 | £1,111.85 | £750.00 | £361.85 | £199,638 | | 12 | £1,111.85 | £745.66 | £366.19 | £198,912 | | 60 | £1,111.85 | £721.58 | £390.27 | £192,287 | | 120 | £1,111.85 | £683.67 | £428.18 | £182,312 | | 180 | £1,111.85 | £635.41 | £476.44 | £169,450 | | 240 | £1,111.85 | £572.62 | £539.23 | £152,565 | | 300 | £1,111.85 | £4.16 | £1,107.69 | £0 |
Total paid: £333,555
Total interest: £133,555 (67% of the original loan amount)
This is why mortgages are expensive — not because the rate is high, but because of the duration.
Why Early Payments Matter So Much
In month 1 of our example, paying an extra £361.85 would eliminate month 2's principal payment entirely — saving £748.64 in interest that would have accrued over 25 years.
Every extra pound paid early cascades through every subsequent payment. The interest saved is not just the rate on that pound — it's that rate compounded over all remaining months.
Rule of thumb: £100 extra per month on a 25-year 4.5% mortgage saves approximately:
- £18,000–£24,000 in total interest
- 3–4 years off the mortgage term
Overpayment Strategies
Regular overpayment: Adding a fixed amount to every payment. Reduces term and total interest. Check your lender's overpayment rules — most UK mortgages allow 10% of balance per year penalty-free.
Lump sum payment: A single large payment directly reduces principal. Best done after receiving a bonus, inheritance, or property sale proceeds.
Offset mortgage (UK): Savings in a linked account offset the mortgage balance for interest calculation purposes. Provides flexibility while achieving the same interest reduction.
Fixed vs Variable Rate Amortisation
The amortisation formula above applies to fixed-rate loans where the interest rate doesn't change.
Variable rate loans (tracker mortgages, ARMs in the US) have the same structure, but the monthly payment recalculates whenever the rate changes. This makes long-term scheduling impossible without assumptions about future rates.
Interest-Only Loans
Some mortgages are offered on an interest-only basis — you pay only the interest each month, and the full principal is due at the end of the term. Monthly payments are lower, but you build no equity and owe the same amount at the end.
With our £200,000 example at 4.5%: interest-only payment = £200,000 × 0.375% = £750/month, versus £1,111.85 for repayment. But at the end of 25 years, you still owe £200,000.
How to Use an Amortisation Calculator
- Enter loan amount (principal)
- Enter annual interest rate
- Enter loan term in years
- The calculator shows monthly payment, total interest, and full payment schedule
Use our Loan Calculator and Mortgage Calculator to generate your full amortisation schedule and see exactly how extra payments reduce your total cost.