Amortisation

Amortisation is the gradual clearing of a debt: the process that takes you from the amount borrowed down to zero, one step at a time. Every instalment has two parts: one pays the interest, the other reduces the debt.

What is interesting is that although the instalment never changes, what it is made of changes every month.

How it works

The order is always the same. First the interest is calculated on the current balance:

$$\text{interest} = \text{principal outstanding} \times \frac{\text{annual rate}}{12}$$

Whatever remains of the instalment goes to the principal:

$$\text{principal repaid} = \text{instalment} - \text{interest}$$

The new balance is the basis for the following month. And that is where the shift comes from: a lower balance means less interest, so more of the same instalment is left for the debt. The debt falls faster, the interest drops again, and the effect accelerates.

How the split shifts

A mortgage of €150,000 at 4% over 30 years, with an instalment of €716.12 throughout:

The first instalment puts €216 towards the debt, the last one €714: out of the same sum. The first ten years clear just under €32,000 of the debt, the last ten almost €71,000.

Why it matters

Amortisation explains a feeling almost everyone with a new mortgage has: "I keep paying, and the debt goes nowhere." It is not an error on the statement. Interest is calculated on what you owe, and at the start you owe the most.

It also says something practical: an overpayment does far more at the start than at the end. All of it goes to the principal, and because it lowers the base the interest is calculated on, it saves you money in every month that follows. The sooner it is made, the longer that compounds.

The same mechanism sits behind the annuity instalment, the one that stays the same throughout.

What to watch out for

Half the time is not half the debt. Fifteen years into a thirty-year mortgage you have not repaid half of it. In our example roughly €97,000 of the original €150,000 is still owed.

When selling a property, the balance decides, not the number of years. What you are left with after the sale depends on the principal outstanding, and that falls more slowly than it seems.

Try it yourself

The mortgage calculator prints the whole amortisation schedule, instalment by instalment, so you can see exactly when the ratio flips. The early repayment calculator shows how much shorter the schedule becomes once an overpayment is added.