Amortisation is the process of paying off a loan through scheduled repayments over time. For a typical principal-and-interest home loan, each repayment covers interest charged for the period and reduces the amount borrowed.
Understanding the basic mathematics helps explain why the balance changes throughout the loan term.
Principal and interest
The principal is the amount borrowed. Interest is the cost of borrowing that amount.
In a typical principal-and-interest repayment, the payment is divided between the interest due and the remaining amount that reduces the principal. The exact allocation depends on the outstanding balance, interest rate and repayment schedule.
Why early repayments often include more interest
Interest is generally calculated using the outstanding loan balance according to the lender's terms. At the beginning of a loan, the balance is usually at its highest, so the interest component can be relatively large.
As the principal decreases, the interest charged in later periods may also decrease, assuming other relevant factors remain unchanged.
A simplified example
Suppose a hypothetical loan has an outstanding balance of $300,000 and an annual interest rate of 6%.
A simplified estimate of one month's interest would be:
[
300{,}000 \times \frac{0.06}{12} = 1{,}500
]
This is an illustration, not a lender's actual calculation. Real loans may calculate interest daily, and repayment amounts depend on the contract and payment timing.
What changes the repayment picture?
Several factors influence amortisation:
- The amount borrowed.
- The interest rate and how it changes.
- The loan term.
- The repayment frequency.
- Additional repayments, where permitted.
- Fees and other contractual conditions.
Extending a loan term may reduce scheduled repayments but can increase the total interest paid over the life of the loan. Making extra repayments may reduce interest in some circumstances, subject to loan conditions.
Why borrowers should understand the schedule
A repayment schedule shows how much of each payment goes toward interest and how much reduces the principal. It can help borrowers understand the longer-term effect of interest rates, repayment changes and loan terms.
Australian borrowers exploring home loan options can learn about the process through Kandid Loans.
Conclusion
Amortisation turns a loan into a series of scheduled payments, but the balance does not fall by the full payment amount because interest must also be covered. Understanding this distinction makes home loan calculations easier to interpret.
This article is for general educational purposes only and is not personal financial advice.
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