The process of amortization is when the total due for a loan is divided into a series of fixed payments to be paid over time. By the end of the payment period, the loan will be paid off completely.
Amortization can help individuals pay off auto loans, home loans, and personal loans in manageable segments to eliminate debt. Mortgages are amortized, and are usually taken out for 15- or 30-year payment periods, depending on the mortgage term and amortization period.
When paying your loan, you initially will be paying more interest than principal. While the percentages of interest and principal payments will eventually shift, the amount of the scheduled payments will remain the same for as long as your mortgage has a fixed rate.
Why Is Amortization Important?
Amortization is important because it allows individuals to pay off their home loans with manageable payments over a set period of time.
Your amortization schedule will also let you know when to expect your mortgage to be completely paid off in full and how much home equity you’re earning. Knowing how much home equity you’ve earned can assist you when applying for home equity loans or lines of credit.
Benefits of Amortization
Amortization uses an “amortization table” to break down your home loan into principal and interest, allowing borrowers to really see how their loan works. While many people will be drawn toward a plan with the lowest payments required, with amortization you can see that the interest is what counts.
A loan with low regular payments can take longer to pay off and end up costing you more in interest. With the breakdown of amortized loans, borrowers can gain a better understanding of where they’re putting their money and how efficiently they can pay off their home.
Amortization Table Example
Here is an example of an amortization table for the following loan terms:
- Loan amount: $250,000
- Loan term: 30 years
- Fixed interest rate: 3.5%
- Fixed monthly principal and interest payment: $1,123
|Year||Principal Payment||Interest Payment||Principal Remaining||Interest Paid|
|1 (Payment 1)||$393||$729||$249,607||$729|
|5 (Payment 60)||$467||$655||$224,243||$41,599|
|10 (Payment 120)||$556||$566||$193,567||$78,281|
|15 (Payment 180)||$663||$460||$157,035||$109,105|
|20 (Payment 240)||$789||$333||$113,527||$132,953|
|25 (Payment 300)||$940||$183||$61,711||$148,494|
|30 (Payment 360)||$1,121||$3||$0||$154,144|
You can see that while the payments remain the same ($1,121), the amount of interest paid is more than the principal payment until after the tenth year of amortization.
Your amortization schedule will only cover the principal and interest segments of your mortgage loan. Keep in mind that other regular payments — such as homeowner’s insurance, homeowner’s association fees, and property taxes — will be the same for their scheduled term, unless their premiums or specific terms change.
How to Calculate Amortization
If you’re curious about how to calculate your amortization, you can find many free amortization calculators online. These are great since you can use them to see how much you’d need to pay monthly in order to completely pay off your loan in a certain amount of time.
Calculating your amortization yourself can be done if you know the equation. To calculate your payments manually, use the equation: M= P[r(1+r)^n/((1+r)^n)-1)].
In this equation:
M: total monthly mortgage payment
P: principal loan amount
r: monthly interest rate (since lenders typically provide a yearly interest rate, divide this by 12 to get your monthly interest rate)
[Related: Seattle’s Current Housing Market]
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