Mortgage amortization is an intimidating-sounding concept (no surprise here – the word “amortization” literally means “to kill off”) that has to do with paying off your home loan. While it can be kind of tricky to understand exactly what amortization is and what it means for your monthly mortgage payments, it’s worth figuring out. Knowing what your amortization schedule looks like can help you decide if it would be more cost-efficient for you to be making additional payments on your mortgage.
What Is Amortization?
Mortgage amortization refers to a loan’s schedule of repayment. It’s how much you’re paying each month and the factors that make up that payment.
Without factoring in an escrow account, a basic mortgage payment consists of two components: principal and interest. Let’s take a closer look at each of these.
This is the loan balance. It’s the amount of money you initially borrowed that you are paying back. As more of your principal is paid off, you’ll pay less in interest. It takes a while before your mortgage payments start to really make a dent in paying off your principal; when you first start making payments, the majority of your monthly payment will be put toward paying interest.
This is how lenders make their money. All loans come with an interest rate, which is taken as a percentage of the principal. A mortgage calculator can tell you how much interest you’ll pay over the life of a loan. For example, if you take out a 30-year loan for $100,000 with a 4.5% interest rate (4.784% APR), assuming you don’t make any extra payments, you’ll end up paying a total of $82,406.87 in interest (in addition to paying back the original $100,000).
How Do My Loan Payments Change Over Time?
With a traditional mortgage, your payment will remain the same total amount every month; however, the makeup of that payment will change throughout the repayment of the loan. When you first start paying off the loan, most of your payment will go toward paying interest. However, as you slowly start to pay off your principal, the amount of interest you’ll need to pay will decrease, so a larger share of your payment will be applied toward principal. This increases the speed with which you build equity.
Put simply: The more principal you owe, the more you’ll owe in interest. If you’re paying off a loan with a set monthly payment and a fixed interest rate, the amount of money you pay in interest will lower each month as your principal is lowered.
What About Overpaying?
While it might be stressful enough to worry about making your mortgage payment without trying to carve out extra money in your budget to make additional payments, if you have the means, overpaying on your mortgage can have its benefits. If you’re able to do so, paying more now can potentially save you tens of thousands of dollars down the road.
Let’s go back to our $100,000, 30-year fixed loan. Your monthly payment on that loan, not including taxes and insurance, would be $506.69. However, if you were to make an additional monthly payment of $50, you’ll save yourself almost $16,000 in interest and shave a few years off the length of the loan as well.
This can make sense if your main goal is to build equity, or if you want to save money on interest. Because all overpayment goes directly to the principal, you’ll pay less interest over the course of repayment, and you’ll pay off your mortgage sooner than if you had stuck with the given amortization schedule.
However, not everybody has the extra money to do this, and those who do might find their money better put toward other things, such as investing.
You’ll also want to watch out for prepayment penalties. Typically, you’ll only be able to pay off 20% of the loan balance in a given year or you may face prepayment penalty fees. This restriction can include selling the home or refinancing the loan, so be sure to consult the fine print of your mortgage before making any big moves in regard to your loan.
Want to figure out the amortization of your mortgage? Check out this easy-to-use mortgage amortization calculator to get a breakdown of your monthly payments and find out how much you could be saving by making additional payments. Need a mortgage or looking to refinance? Get started online with Rocket Mortgage® by Quicken Loans.
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