What is mortgage amortization?

What is mortgage amortization?

Mortgage amortization describes the process by which a borrower makes installment payments toward a loan balance over a set period. These payments are divided between principal, or the amount borrowed, and interest, or what the lender charges to borrow the funds.

The longer the loan amortization period, the lower your monthly payment. That’s because the more time you have to repay a balance, the less it will cost you each month.

The downside to a longer amortization period, however, is that you’ll spend more money on interest. In addition, because the interest payments are frontloaded with a longer mortgage, it takes more time to reduce the principal and build equity in your home — a factor to consider when comparing your loan options.

How amortization works with fixed-rate mortgages

With a fixed-rate mortgage, the monthly principal-and-interest payments remain the same throughout the loan’s term. However, each time you make a payment, the amount of the payment that goes to the principal differs from the amount that gets applied to interest — and this balance shifts a bit with each payment.

“As your loan matures, you can expect a higher percentage of your payment to go toward the principal, with a lower percentage going toward the interest,” says Nishank Khanna, former chief marketing officer at Clarify Capital in New York City.

How amortization works with adjustable-rate mortgages

On the other hand, an adjustable-rate mortgage (ARM) comes with a fixed interest rate for an initial period, usually between three and 10 years. After that, your rate — and, therefore, your monthly mortgage payment — will change every six or 12 months, depending on the type of ARM you have.

Like fixed-rate mortgages, you’ll pay a bigger chunk toward the interest at first. Over time, this will shift, so more of your payment goes toward the loan principal.

How do you calculate mortgage amortization?

Daily Tech Finance’s amortization calculator can help you understand how your payments break down over the life of your mortgage. To use the calculator, you’ll need to input a few details about your mortgage, including:

• Principal loan amount
• Loan term (such as 30 years)
• Loan start date
• Interest rate
• The amount and frequency of extra payments, if applicable

With this information, the calculator can tell you how much principal and interest you’ll pay in any given monthly payment and how much principal and interest you’ll have paid by a specific date.

Mortgage amortization schedule example

Let’s assume you took out a 30-year, fixed-rate mortgage for $400,000 at 6.7 percent. At those terms, your monthly mortgage payment — including principal and interest — would be about $2,581, and the total interest over 30 years would be $529,200.

Here’s what your loan amortization schedule would look like in the first year of the loan term:

Here’s what your amortization schedule would look like in the final year:

This example illustrates how the amount of your payment that’s allocated to the principal increases as the mortgage moves toward maturity, while the amount applied to interest decreases.

Amortization schedules — and how the payment is distributed to the interest and principal — can vary based on factors like how much you’re borrowing and your down payment, the length of the loan term and other conditions. Using Daily Tech Finance’s calculator can help you see what the outcomes will be for different scenarios.

What should borrowers know about mortgage amortization today?

When it comes to a mortgage, most buyers choose a 30-year loan without thinking much about it. But there are cases when the default loan term and amortization schedule might not be the best fit — especially if you’re making a low down payment and don’t plan to stay in the home for long.

“Say, for example, you purchased a starter home intending to live in it for only five years before upgrading to a larger house,” Khanna says. “You expect to make a profit when you sell, but you find out that you owe more than the value of the house. That’s because of your chosen amortization schedule and a slight depreciation [in the] home’s value. In this scenario, you opted for a 30-year mortgage over a 15-year loan, and most of your payments went toward interest rather than the principal balance.”

Understanding your amortization schedule can also help you choose a strategy for prepaying your mortgage. If you can afford to make extra payments on your mortgage, you’ll lower your principal balance more quickly and reduce the amount of interest you pay on your loan.

For example, let’s say you have a $200,000, 30-year loan with a 6.5 percent interest rate. By making an extra $100 payment each month, you would save $55,944 in interest over the life of your mortgage. You’d also pay off your loan five years and seven months earlier than if you didn’t make the extra payment.

FAQ

• How does refinancing affect mortgage amortization?

  Refinancing can be a great way to secure a lower interest rate or more favorable loan terms. But when you refinance, you’re replacing your current mortgage with a new one. Doing so can reset the timeline for fully repaying your mortgage, as well as the loan amortization schedule. If you choose to start over with a 30-year loan, you’ll find that a larger portion of each monthly mortgage payment goes toward interest once again.

• How does mortgage amortization affect home equity?

  When you first get a mortgage, a larger percentage of each monthly payment goes toward interest rather than toward repaying the principal. As a result, amortization slows the process of building equity in your home.

• What is negative amortization?

  Negative amortization happens when the payments you’re making don’t cover the interest on the loan, and your balance grows instead of shrinking. This might be the case if your lender allows you to make interest-only payments. Over time, if the amount you owe ends up exceeding the value of your home, you’ll be “underwater” on the property, making it more difficult to sell and use those proceeds to repay the mortgage.