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How Mortgage Amortization Works


If you’re a homeowner and you’ve begun the process of paying off your mortgage, you’re dealing with something called mortgage amortization. Amortization is the act of eliminating debt by making regular payments over time according to a set schedule. Having a clear sense of how it works is important if you’re trying to pay off your mortgage. If you want more hands-on guidance as you go about the process, consider finding a financial advisor.

What Is Mortgage Amortization?

In order to understand mortgage amortization, you must understand the difference between paying interest and paying off a loan’s principal balance.

The principal is the amount of money someone borrows from a lender. So if you take out a $250,000 mortgage, your principal balance is originally $250,000. Your interest is effectively the fee your lender charges for allowing you to use their funding. Because of interest, what you’ll owe for buying a home exceeds the $250,000 you took out to finance your purchase.

Through home loan amortization, you’re paying off a mortgage but you’re not just paying back the money you borrowed. In fact, when you first begin making mortgage payments, most of your money will go toward paying interest. Very little of it will be used to cover the principal balance until you get closer to the bottom of your amortization schedule.

As a borrower, your goal is to make on-time payments every month so that the principal loan balance gets smaller and smaller and eventually reaches zero. With each mortgage payment, you build home equity and own a larger percentage of your house.

The Mortgage Amortization Formula

Mortgage Amortization

The percentage of your mortgage payments that go toward interest and your principal balance isn’t arbitrary. This comes to fruition in a “loan amortization formula.” If you want , you can crunch the numbers yourself and create your own amortization chart. That way, you’ll have a better idea of how your home loan will amortize.

To find out how much of your first mortgage payment will cover the interest you owe, you’ll need to multiply your original loan balance by the periodic interest rate. The product will be the amount of interest that’s due. From there, you can subtract the interest payment amount from the total payment amount to get the portion that’ll be used to cover the principal.

Say that you take out a $200,000, 30-year fixed-rate mortgage with a 4.25% annual interest rate. Your first mortgage payment is $984. Your monthly interest rate would then be 0.354%, which is 4.25% divided by 12 months.

So when you make your first payment, you will pay $708 in interest ($200,000 x 0.00354) and the remaining $276 will go towards your principal ($984 – $708 = $276). That leaves you with a loan balance of $199,724, which is $200,000 – $276 (your principal). Since this is a fixed-rate mortgage, you can multiply the remaining balance by the monthly interest rate to figure out how much of your second payment will go toward interest ($199,724 x 0.00354 = $707). You can then repeat the process to complete your loan amortization chart.

Here’s a longer-term breakdown of this example:

Example of Mortgage Amortization

Month #1Month #13Month #25Month #37Month #49
Interest Amount$708$696$684$671$657
Principal Amount$276$287$300$313$327
Overall Balance$199,724$196,341$192,810$189,127$185,284

Certain home loans come with balloon payments so they don’t fully amortize over time. In other words, these mortgages allow you to make small monthly payments that aren’t large enough to pay off the entire loan balance. As a result, you have to make a lump sum payment at the end of the loan term.

You can make an amortization schedule if you have to make a balloon payment. Let’s say you have a seven-year fixed-rate balloon loan, and it requires you to make a $60,000 balloon payment. Your amortization table would show you making equal payments every month for six years. But in year seven you would have to pay $60,000, unless you can sell your house or refinance your loan.

Understanding Your Amortization Schedule

An amortization schedule is a detailed chart that breaks down loan payments over the years. It explains how much of each payment will apply to interest versus the principal balance. You’ll find amortization schedules for amortization loans (or loans you pay off through regular installments that cover the interest and principal balance) that have a pre-determined payoff deadline, like mortgages and car loans.

If you were to look at an amortization table, you would probably see the monthly payment date, the payment amount, the amount that covers the principal and the amount of the payment that covers the interest. You’ll also likely see the total amount of interest you’ll have paid after making each payment and the size of the remaining loan balance.

Anyone who has a 30-year mortgage will have a home loan amortization schedule that includes a breakdown of all 360 payments (12 payments a year for 30 years) needed to pay off their mortgage. If you have a 15-year mortgage, you’ll see 180 payments. There are amortization schedules for both fixed-rate and adjustable-rate mortgages, although the ones for the latter might be more of an estimate, since interest rates can change as the loan matures.

Negative Amortization

Mortgage Amortization

Mortgage lenders can give borrowers the option of making small monthly payments if that’s all they can afford. But if those minimum payments are too small and they don’t even cover the amount of interest that’s due, a homebuyer will eventually have to deal with negative amortization.

Negative amortization occurs when a borrower’s principal loan balance goes up over time due to unpaid interest. The interest gets added to the principal, forcing the homeowner to pay interest on top of interest.

Say, for instance, that you take out a $260,000 loan. Instead of that number decreasing monthly, you could see that $260,000 rise to $280,000 or $300,000 thanks to negative amortization. This can occur when you have a graduated payment mortgage or a payment-option adjustable-rate mortgage.

Bottom Line

Amortization is paying down debt over a period of time through scheduled payments. When someone pays off a home loan, he engages in mortgage amortization. This payment process is key when trying to understand how much you can afford to pay monthly for a mortgage. Not paying enough means that you’ll end up paying more interest and more money as time passes.

Tips for Determining Which Mortgage Is Best for You

  • Before you start your home search, try to figure out how much you can afford to spend on a house. This will, in theory, keep you from falling in love with a home that you cannot manage to pay for. For some insights into this issue, stop by SmartAsset’s home affordability calculator.
  • Financial advisors have wide-sweeping knowledge about the investing world. However, many of these financial professionals deal with multiple areas of financial planning, including mortgages. So it might be worth consulting an advisor if you want to integrate a major home loan into your life. SmartAsset’s financial advisor matching tool can set you up with as many as three fiduciary advisors in your area. All you have to do is answer our questionnaire about your current financial state and needs.

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