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Oct 30, 2021 | By Benie Khan
How Does Mortgage Amortization Work?

How Does Mortgage Amortization Work?

What is Mortgage Amortization?

 

When you take out a mortgage, you make equal monthly payments determined by your mortgage amortization. Your mortgage payment is part principal and part owed interest to pay the debt off by its maturity date.

 

Understanding how mortgage amortization works makes it easier to understand your mortgage and how to pay it off faster.

 

Mortgage Amortization Defined

 

The definition of mortgage amortization is the gradual reduction of the loan amount owed over a given period of time. It shows you how much principal and interest you pay each month. At the start of any amortization schedule, you pay mostly interest and very little principal. As you get closer to the loan’s maturity, you’ll pay more principal and less interest.

 

How Does it Work?

 

Your amortization schedule is made up of two parts:

 

  • Principal – The principal is the amount of money you borrowed to buy the home. For example, if you borrowed $400,000 to buy a home, your principal is $400,000 and is amortized over the life of the loan whether 15, 20, or 30 years.

 

  • Interest – This is what lenders charge to lend you the money. You may have a fixed interest rate or variable rate that changes annually.

 

If you stick to the amortization schedule, you’ll pay the loan off as described. You’ll see on your schedule with each payment how much your principal drops.

 

In the beginning, a small portion of the payment goes towards the principal; the majority will go towards the interest.

 

If you have a fixed-rate mortgage, more of each payment will go towards the principal.

 

If you make extra payments towards the principal, you’ll speed up the amortization process and pay less interest since you pay the principal balance down faster. As a result, your house loan will be paid off faster.

 

How to Calculate your Amortization

 

If you want to know how much of your monthly payment covers principal and how much goes to interest, it’s a simple calculation.

 

Take your annual interest rate (the interest rate you were quoted) and divide it by 12. This is your monthly interest rate. Next, multiply your outstanding mortgage balance by the interest rate.

 

Let’s say for example, you borrowed $400,000 at 3.75%. Your monthly payments would be $1,852.46 but your first payment would cover $1250 in interest and only $602.46 in principal. As you pay the balance down, though, the tables turn.

 

Once you get your balance down to $360,309, your payment would consist of $1128.23in interest and $724.23 in principal. The amount of principal you pay each month would steadily increase, and the interest decrease.

 

Making Extra Payments

When making a payment that is larger than the required payment.

 

Applying the extra payment towards the principal will save you money. As a result, you’ll pay your house off faster and save money by paying less interest.

 

For example:

 

A 30 year fixed mortgage of $400,000 with an interest rate of 3.75% has a monthly principal & interest payment of $1,852.46.

 

Making an extra $100 payment each month that is applied towards the principal will reduce the amount paid on loan.

 

The scenario below is based on month 1 of the payment schedule:

 

Regular payment: interest paid is $266,887

 

Extra payments 

$100 per month: interest paid is $239,691

$200 per month: interest paid is $217,760

$300 per month: interest paid is $199,658

 

Try the calculation yourself: mortgagecalculator.org

 

Final Thoughts

 

It’s essential to understand how mortgage amortization works. You’ll get the most out of your mortgage and possibly pay it off faster if you know how much of your payment covers principal and how much covers interest.

 

If you can make extra payments at the front of your mortgage, you’ll make the largest impact on the total interest charges, but additional payments at any time are helpful. The key is to know how much principal is left and to ensure any extra payments you make cover the principal and not any other charges.

 

 

 

 

 

Tags: mortgage, first time home buyer

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