Amortization wordcloud concept illustrationIf you have ever had a car loan or even a mortgage loan then you have heard the term mortgage amortization. If  you have ever wondered how it works and how your payments get applied keep reading!

Amortization is defined as as the reduction of debt by regular payments of interest and principal sufficient to pay off a loan by maturity. In simple terms it means, how your mortgage payment is distributed on a monthly basis showing how much goes to interest and principal each month. By understanding how the amortization of your loan works you are better able to understand how the balance is paid of monthly and yearly. By following an amortization schedule it will show you the amount of interest you will pay over the life of the loan assuming you hold the loan until its paid off.amortization-schedule

 

(This chart shows how the mortgage principal begins to increase as the interest amount decreases)

If you were to obtain, let’s say, a 30-year fixed rate loan the first half of the term of that loan would go towards paying down the interest and paying very little towards the principal. This is important to note because if you are a homeowner that refinances (assuming you refinance into the same type of loan) every few years you will find yourself paying back a lot of interest and every time you refinance you go back to paying a good portion of the interest on your mortgage. This is not necessarily the case if you are more than half way through your loan term as you are now paying into a good portion of the principal. One important thing to consider, if you have already paid down a good portion of your mortgage but still want to refinance to take advantage of low mortgage rates, consider a shorter-term mortgage to avoid the “resetting of the clock” per se.

Now let’s take a look at how a mortgage amortization works,

Loan amount: $100,000
Interest rate: 6.5%
Monthly mortgage payment: $632.07

You obtain a $100,000 loan at 6.5% on a 30-year fixed payment. The monthly principal and interest payment is $632.07. If you break down the very first monthly mortgage payment, $541.67 goes toward interest and $90.40 goes toward principal. The total debt is reduced by $90.40, so next month you’ll only owe interest on $99,909.60. So when it comes time to make your second monthly mortgage payment, interest is calculated on the new, lower balance. The payment would be the same, but $541.18 would go toward interest and $90.89 would go to principal. This interest reduction would continue until your monthly mortgage payments were going primarily to principal. In fact, the 360th payment in our example contributes just $3.41 to interest and a whopping $628.66 to principal.

(Source: Truth About Mortgage)

So now that you have a better idea of how mortgage amortization works the next thing you will want to decide is if paying down your mortgage faster is a good idea. Let’s use the example above and say you make $700 payments each month instead of the $632.07.  Your mortgage term will be cut by approximately seven years and  you’ll pay $76,448.10 in interest saving you about $50,000 over the life of the loan! Consider bi-monthly mortgage payments as you will end up paying 26 payments over the course of a year which equates to 13 months instead of paying 12 months. That extra payment goes toward lowering the total the principal which in turn will lower the amount of interest you pay and decrease the life of the loan.

If you have a good idea of how a mortgage amortization works you can apply these principals to your loan and hopefully save some green along the way! For more information on your mortgage amortization schedule for your current mortgage loan or to speak to a mortgage officer about obtaining a mortgage loan, contact us here, we would love to hear from you!