Mortgage 101: What Is Amortization & How Does It Affect Your Loan?

Posted by Laine Smith on 3/3/15 10:51 AM

Topics: First Time Home Buyer Interest Principle home buying

One of the biggest perks of a fixed-rate mortgage is the consistent monthly payment. While a borrower’s fixed-rate monthly mortgage payment remains the same for the life of the loan, the amount of payment going toward the loan’s principal and interest varies monthly as it is paid down. This is known as amortization.

MORTGAGE101-Amortization

Amortization is used on loans, like auto and home, which have a payoff date. Early on in a loan schedule, the majority of payments go toward interest, diminishing a bit with each payment, and eventually the majority of the amount goes toward the principal balance.

When determining you mortgage amortization it is important to note that the interest rate of your home loan is an annual rate. Because loan payments are based on a monthly schedule, your interest rate is converted to a monthly rate.

For instance, let’s say your starting loan amount is $200,000 with an interest rate of 4 percent. Your monthly interest rate would be 0.333% (4%/12=0.333%). Your monthly payment would be consistent each month at $954.83 for principal and interest, but each month the interest rate of 0.333% is applied to your principal balance, changing the interest and principal payments.

An amortization schedule represents that change of interest and principal. Using the same example and our loan amortization calculator, here is how your loan amount would amortize over the first three years of your loan.

AmortizationTable

How Amortization Affects Your Mortgage

One of the main reasons homeowners are interested in their loan’s amortization schedule is because of how it affects their home equity, the difference between the balance of their loan and fair market value. When the majority of monthly payments are applied to interest, less goes to principal, meaning you gain less equity in the first years of your mortgage until reaching the crossover point where more is applied to principal and less to interest.

For the example above, this crossover point is met after 152 monthly payments, though there are pre-payment strategies to pay down your mortgage quicker, avoiding interest charges and gaining equity at a faster pace.

To easily determine the amortization of your loan, use our amortization calculator. For more information on home buying and financing, download our Mortgage 101 Handbook.

 

New Call-to-action

Subscribe to Email Updates

Posts by Topic

see all