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What is mortgage amortization?

Mortgage amortization is a financial term that refers to your home loan pay off process. When you take out a mortgage, the lender creates a payment schedule for you. This schedule is straightforward and, if you have a fixed-rate mortgage, consists of equal installments throughout the life of your loan. What you may not know is that part of this monthly payment covers interest while another part goes toward your loan principal. Although the monthly payment amounts remain fixed, it's important to realize that the allocation of those dollars is gradually adjusted as you pay off your mortgage.

Here's everything you need to know about principal and interest payments and how they can affect your loan pay off. Understanding your home loan amortization schedule can help you make informed decisions regarding your mortgage.

How home mortgage amortization works

When you make your monthly mortgage payment, the lender divides the total amount into two buckets:

  • Principal: This is the outstanding balance on your loan.
  • Interest: This is the cost of financing your home.

Some mortgage payments may include an amount for escrow, which is used to pay items such as your property tax and homeowners insurance.  However, some loans may allow you to pay those amounts on your own and limit your mortgage payment to Principal and Interest (P&I) only.  The following refers to your P&I payment.

At the beginning of your loan pay-off period, the bulk of your payment is applied to the interest bucket with a small portion going toward the principal. As the lender covers the cost of financing your home purchase, the payment allocation begins to change. Over time, a larger percentage of your payment goes toward the principal and less to interest.

If you keep close track of your loan balance, you’ll notice the amount you owe diminishes slowly at the beginning of your loan. You’ll also notice that it drops much faster toward the end of the pay-off period since interest is calculated on the loan balance. The loan balance reduces every month as you pay off your mortgage. Therefore, so does the interest.

During the first years of your mortgage, you’re paying off more interest so it’s normal for the balance owed to decrease gradually while your home equity increases slowly. But during the final years of the home loan, the opposite will happen. At the beginning of your loan, you pay more interest. Then, as your loan ages, more of your payment goes toward the principal. Your balance owed will decrease quickly as you build home equity exponentially since you’re now paying off more of the principal.

Sample home mortgage amortization schedule

The complete breakdown of your payments is available in an amortization schedule, also known as an amortization table. This is where you can see how much of your payment applies to principal and interest. It also provides information on the remaining mortgage balance as well as your loan’s fixed end date.

Below is a sample amortization table for the first few monthly payments of a $500,000 home loan at a 3.1% interest rate, as well as another few months much later in the loan:

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Amortization schedules show how a loan’s principal balance owed goes down over time as the amounts of total principal and interest paid increase. As the loan progresses, more of a payment is applied to the principal balance owed and less is paid in interest. This simplified example shows a 30-year home loan (360 total monthly payments) starting with a principal amount of $500,000 borrowed and a fixed interest rate at 3.1%.

The first monthly payment of $2,135 applies $843 to principal and $1,292 in interest. As each payment is made, more is applied to principal and less to interest.

In this example, at about year five, $982 of your monthly payment goes toward principal and $1,153 to interest. So far you’ve paid $54,661 toward principal, leaving  principal balance owed at $445,339 and $73,444 in paid interest. By year 20, your principal paid is $279,939 with $220,059 remaining, and interest paid of $232,479.

When the loan is about to be paid off at month 360, about $2,130 goes to principal and $6 goes to interest. The balance owed has gone down throughout the process.

Keep in mind this example does not reflect all changes to the loan; you can make additional principal payments that could change your outcome, and it does not show taxes, insurance or other fees. Having an adjustable-rate mortgage could cause amounts applied to principal and interest to change over time, as well.

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Your lender should be able to provide an amortization schedule, but you can also make your own.

How payments affect principal, interest and pay off

As you can see from the example above, amortization tables clearly lay out your payments and break them down throughout the life of your loan. When you understand the repayment process of your loan, it’s easy to see how payments relate to the loan principal, interest amount and pay off.

A home amortization schedule also clarifies how making added payments toward principal can have a significant impact on the total cost of your loan. Because interest owed is calculated on the loan balance, extra payments towards your principal lower this balance at a faster rate and can considerably decrease the amount of interest you owe. Although your interest rate stays the same with a fixed-rate loan, paying a bit extra each month can ultimately make the loan cheaper and help you pay off the balance faster. And while this information may seem intuitive, nothing compares to seeing the actual numbers.

If you’re looking to make additional loan payments and need a clear picture of your potential savings, ask your lender to provide an amortization schedule. You can also use an online amortization calculator. This can help you plan for extra payments to reduce the length of your loan. If you’ve set a goal of a specific pay off date, this simple table can tell you exactly how much more you need to pay each month.

How loan terms affect principal and interest

When deciding on a loan term, many home buyers opt for longer loans with smaller monthly payments. With an amortization table, it’s easy to see how lower monthly payments can end up costing you more in the long term.

By comparing amortization schedules for different loan terms, you can calculate the cost of a longer loan term. This provides tangible numbers so you can understand the additional expense of a longer loan term and decide which option is best for you.

Refinancing

A loan amortization schedule can also be useful when trying to decide if a refinance is right for you. This table lays out how a shorter- or longer-term refinance can affect your overall payment amounts. It can also help you understand the tradeoffs involved with refinancing.

While the changes in monthly payments may not seem significant at first, an amortization table predicts your total savings for the duration of your loan. This is the best way to see a clear picture of the potential savings and determine if refinancing is the way to go.

How to create an amortization schedule

An amortization table can provide valuable information for borrowers to consider when taking out a home loan or reviewing their existing mortgage. This useful tool is essential for effective financial planning and greater lifetime savings.

  1. With the monthly payment amount determined by the lender, simply take the total loan amount and multiply it by the interest rate. This is your annual interest payment amount. Using the numbers from the table above, the math looks like this:
    $500,000 x .031 = $15,500
  2. Divide the annual interest payment amount by twelve to calculate your first monthly interest payment.
    $15,500/12 = $1,291.67
  3. Subtract this interest amount from the monthly installment to calculate your payment to principal.
    $2,135.08 – 1,291.67 = $843.41
  4. Update the loan balance to reflect the first payment and repeat this process for every month until you reach a principal balance of zero.

Knowledge is power

Mortgage amortization tables are a multi-functional tool that are easy for borrowers to understand. They deliver a great deal of information and put your financial obligations in perspective when it’s time to take out a home loan or to evaluate your existing loan.

Understanding the breakdown of your mortgage payments is a useful way to manage your debt and plan for your financial goals. An amortization schedule helps you better track and plan out your mortgage payments. With our extra payments calculator, you can also project the potential savings from making additional payments on your home mortgage.

These handy tools can make a significant difference in your financial outlook. They provide a better understanding of the fees and costs associated with a home loan, so you can make financial decisions with confidence.

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