Understanding Mortgage Amortization Can Save You Money

Anyone who plans to buy a home should be familiar with mortgage amortization. Mortgage amortization is the process which takes place when a home owner pays on his mortgage loan, decreasing the principal amount owed over time. During the first years of the mortgage, amortization happens slowly as most of the payments go toward paying the interest due on the mortgage loan. Gradually, over the course of the life of the loan, more of the money goes towards paying the principal, decreasing the principal loan amount owed. It can sometimes take as long as half the life of the loan life for the principal payments to equal the interest payments on a mortgage loan. As the owner pays more towards the principal balance, the equity in the home increases.

How amortization works

Amortization is the process of bringing a debt down to a zero balance. The word “amortization” is based on the French word “amortir” which means causing death to something. To understand amortization, a person must also understand the terms involved:

  • Principal: The principal of the loan is the initial amount borrowed without any interest or fees added.
  • Interest: The interest on a loan is the price one pays to be able to use someone else’s money to purchase a home. This amount is normally expressed as a percentage and applies to the principal over the life of the loan.
  • Time: The time refers to the term of the loan. This is the amount of time it will take the buyer to pay off the mortgage loan. Common mortgage loan terms are for 5, 7, 10, 15, or 30 years. The longer the home owner takes to pay off his loan, the more interest he will have to pay over the life of the loan.

The purchase price of the home, plus taxes, insurance, interest, and other fees equal the total cost of the mortgage loan. During the early years of most mortgage loans, the total monthly mortgage payment goes toward paying the interest on the loan. After these early years of the loan, more of the payment is applied toward the principal balance of the loan.

The remaining payments are divided between interest and principal, until there is a zero balance and the mortgage loan has been paid off. The formula for calculating mortgage amortization is derived by totaling the amount of interest and calculating the average. If a person pays more than his required monthly payment, this can change the mortgage amortization figures. Figuring an amortization schedule can be complex and is why many people use the assistance of mortgage amortization calculators to help them see the breakdown of their monthly mortgage payments.

Understanding Mortgage Amortization Can Save You Money

Mortgage amortization schedule

The mortgage amortization schedule shows the breakdown of the monthly payments, along with how much of the payment is being applied to the interest and to the principal balance of the loan. The amortization schedule shows the balance of the loan, which is divided by the number of monthly payments on the mortgage note. The interest calculation is on the unpaid balance and is added to the loan amount. Most mortgage amortization schedules will show payments which the majority of the payment going towards paying the interest in the early years of the life of the mortgage loan.

Mortgage amortization calculators

A mortgage amortization calculator helps home buyers find the breakdown of the principal and interest in their mortgage payments. To use one of the calculators, the home owner must enter both loan and property information. The home buyer enters the loan amount, annual interest rate, number of months the loan is financed, and whether he wants a yearly or monthly breakdown of the mortgage payments. For the property information, the user enters the purchase price of the property, and the yearly amounts of property taxes and insurance. After entering this information, the mortgage amortization calculator will give the user a breakdown of each monthly payment; showing the starting balance, the interest payment, the total payment, and the ending balance.

What is the significance of understanding mortgage amortization?

Home owners who research mortgage amortization over the life of their mortgage loans can find out how long it will take them to pay down their principal balance. Knowing this information is a helpful tool in deciding which type of mortgage loan to obtain and the term of the mortgage loan desired. With this information in hand, the homeowner can approach a mortgage lender with an idea of the payments he can afford to make on a mortgage loan or find out what other mortgage loans or payment options may be available. Home owners may also choose to seek professional mortgage advice to determine the best type of mortgage loan for their unique individual circumstances.

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