What’s an amortization? How a Mortgage Amortization Plan Works

What is Mortgage Loan Repayment?

Mortgage loan repayment is the payment of a home loan up to $ 0.

A mortgage – or any other type of loan – is “amortized” when it is paid in regular installments and repaid in full after a set period of time.

Your mortgage amortization schedule will determine when your home will be repaid and how quickly you will build home equity. It also comes into play when you want to repay the loan early. Hence, it is important to understand how your repayment plan works.

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How Mortgage Amortization Works

If the amount you borrow for a mortgage loan is to be repaid in installments, your loan will be written off.

"Loan write-down is the calculation of the loan payments that amortize – that is, repay – the loan amount," said Robert Johnson, professor of finance at Creighton University's Heider College of Business.

"With a full amortization loan, the loan payments are set so that no loan balance is outstanding after the final payment."

The amortization also determines what part of your monthly loan payment is used for principal or interest.

At the beginning of your repayment schedule, a larger percentage of each monthly payment goes towards loan interest. In the end, you pay more for the principal.

Note: This only affects the breakdown of your payments. If you have a fixed rate mortgage, the total payment amount will always be the same.

This background math doesn't seem to matter, especially since most mortgages have fixed payments.

In fact, however, the breakdown of payments is very important as it determines how quickly you build home equity – which in turn affects your ability to withdraw equity, refinance, or repay your home early.

Are all mortgage loans written off?

Almost all mortgages are fully written off – that is, the loan balance reaches $ 0 at the end of the loan period.

Exceptions are unusual types of loans such as balloon mortgages (which end up requiring a large payment) or interest-free mortgages.

Most lenders don't offer these – and most home buyers don't want them – because these loans are riskier and won't help the borrower build equity anytime soon.

With an amortized loan, your mortgage is guaranteed to be paid back to maturity as long as you make all of your payments over the life of the loan.

How the amortization will affect your loan payments

Your repayment schedule doesn't just dictate when your mortgage will be paid back. It also defines how each monthly mortgage payment is split between interest and loan capital.

"While the monthly loan payment is likely to stay the same, the interest and principal component will be different for each subsequent payment," explains Johnson.

"The first time you make a principal payment – the first month – you pay the largest percentage for interest and the smallest percentage for principal.

"Conversely, the last payment you make – month 360 for a 30-year mortgage loan – the largest percentage of your payment is used for principal and the smallest percentage is used for interest," says Johnson.

The longer the term of your loan, the longer it will take to repay your principal borrowed and the more you will pay in total for interest.

Because of this, a shorter term loan like a 15 year fixed rate mortgage has a lower total interest cost than a 30 year mortgage.

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Example of a repayment plan

Here is an example of what a repayment schedule for the following loan would look like:

Loan Amount: $ 250,000 Loan Term: 30 Years Fixed Rate: 3.5% Fixed Monthly P&I Payment: $ 1,123

Mortgage depreciation table

Each payment is equal to the total amount ($ 1,123). Note, however, that more than half of the payment is used for interest in the first year, while only $ 3 is used for interest at the end of year 30.

Capital payment
Interest payment
Main whereabouts
Interest payment
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
fifteen (Payment 180)
$ 663
$ 460
$ 157,035
USD 109,105
20th (Payment 240)
$ 789
$ 333
$ 113,527
$ 132,953
25th (Payment 300)
$ 940
$ 183
$ 61,711
$ 148,494
30th (Payment 360)
$ 1,121
$ 3
$ 0
$ 154,144

Mortgage repayment table

As you can see in the table below, the principal paid by the homeowner does not exceed the interest amount until year 19.

Examples created with The Mortgage Reports mortgage calculator

The depreciation only affects capital and interest

Note that your amortization schedule only affects the principal and interest (P&I) portion of your mortgage payment.

Regular payments also include other home ownership costs; such as homeowner insurance, property taxes and, where applicable, private mortgage insurance and / or homeowners association (HOA) fees.

Payments for these other expenses are not affected by your amortization schedule. However, they can change throughout the life of the loan – for example, if your property tax rates or homeowner insurance premiums change.

Why Your Amortization Plan Is Important

"Payback is important because the faster you can amortize your loan, the faster you build equity and the more money you can save over the life of your loan," says real estate investor and pinball company Luke Smith.

Take a close look at your repayment schedule and you will likely find that your loan pays for itself much more slowly than you think.

"Many borrowers find it difficult to understand how little of their monthly payment is used to repay principal at the beginning of the life of their loan and how much of the monthly payment is used to repay principal late in the life of their loan," he says Johnson.

Homeowners may not pay attention to their repayment schedule because their total payment does not change.

However, if you are looking to get home equity or want to repay your loan sooner, these numbers play a role between principal and interest.

Build home equity

At the end of a fully amortizing mortgage loan, you will own your home completely. Its value will be 100% equity.

However, because of the way mortgage loans pay for themselves, that equity is slowly building up.

For example, you cannot assume that by the time you close half the loan term, you will own half the home.

Consider the example above. Although the full loan term is 30 years, it takes the homeowner 19 years – almost two thirds of the term – to repay half of their loan capital.

If you took out the same loan amount ($ 250,000) over a 15 year term instead of a 30 year term, by the 9th year you paid back half of the loan.

So, not only will a shorter repayment plan help you save money on interest, but it will also help you build more degradable home equity.

Remember, you need more than 20% equity to capitalize on the value of your home through a payout refinance or home equity loan. Your repayment schedule will help you understand when you can hit the magic number to be eligible for home financing.

Paying back your mortgage

Some homeowners choose to repay their mortgage early to save interest payments.

One way to do this is to refinance into a shorter loan term such as a 10, 15 or 20 year mortgage.

For homeowners who do not want the hassle and cost of refinancing, an alternative is to make additional or "expedited" payments to the loan capital. Early payments can be made in the form of:

One additional payment per year. Extra money is added to each monthly payment. A one-time lump sum payment

Making early payments on the principal of your loan can help shorten your repayment schedule. You save money because you do not have to pay interest for the months or years that have been deleted from your loan term.

You can use an amortization calculator with additional payments to determine how quickly you could potentially pay off your remaining balance and how much interest you would save.

Should you choose a long or short repayment schedule?

Before you decide on a mortgage loan, it's important to pinpoint the numbers and determine whether you are better off with a long or short repayment schedule.

The most common term for mortgages is 30 years. But most lenders offer 15 year home loans as well, and some even offer 10 or 20 years.

So how do you know if a 10, 15, or 20 year amortization plan is right for you?

Benefits of a Short Term Loan

The obvious benefit of a shorter repayment schedule is that it saves you a lot of money on interest.

For example, consider a $ 250,000 mortgage at 3.5% interest:

A 30 year fixed loan would cost you a total of $ 154,000 in interest. A 15 year loan would only cost you $ 46,000 in total interest

"Short amortization schedules are usually a good financial decision when you're buying a starter home and looking to build equity faster," said Nishank Khanna, chief financial officer of Clarify Capital. "It means you pay more up front for the client."

Khanna continues, “Borrowers making a large down payment or planning expedited payments, or those securing loans with low annual percentages, can cut their amortization schedule – making them pay less money over the life of their loan and build home equity much faster. ”

However, a shorter repayment schedule is not for everyone.

Disadvantages of a short term loan

The main downside to shortening your repayment term is that the monthly payments are much higher.

For the same example of a $ 250,000 loan at 3.5% interest:

The monthly P&I payments for a 30 year loan are $ 1,200. The monthly P&I payments for a 15 year loan are $ 1,600

The sharp increase means that many homeowners simply cannot afford a short-term mortgage.

If you opt for a shorter term loan, your higher monthly payments will be blocked. You are required to pay the full amount each month.

On the other hand, a longer term loan allows you to pay more to expedite your repayment schedule if you so choose. However, you are not required to pay a higher monthly payment.

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Can you change your repayment schedule?

The good news is that even if you opt for a longer repayment schedule – a 30-year fixed-rate mortgage, for example – you can shorten your amortization and pay off your debt faster:

Refinancing to a shorter term loan; or expedited mortgage payments

Smith recommends making additional principal payments instead of choosing a 15 year loan.

“Get the cheapest price and the best conditions for yourself. Then if more funds are available in your budget, you will pay off your loan faster than planned, ”he says.

Smith explains that “by making accelerated payments, you can treat your mortgage like a 15 year mortgage rather than a 30 year loan. Most mortgage loans and lenders allow you to waive fees or penalties.

"This way, when a financial challenge arises and you need the funds, you can temporarily or permanently stop executing expedited payments with no problem or impact."

Should You Shorten Your Amortization Schedule?

“If interest rates are low and the majority of your payments are going towards capital, this may be the case Not be a strong argument in favor of paying off a mortgage faster, ”suggests Khanna.

“If you think you can get a higher return on investments other than the stock market, avoid a short term repayment schedule.

"Also, remember that if you repay your mortgage earlier, you will lose tax breaks that you may qualify for, such as mortgage interest tax deduction, which can wipe out savings."

Mortgage Amortization: A Personal Choice

The decision between a short term or a long term loan should depend on your personal finances.

If you have a high monthly cash flow and want to save interest, choosing a 15 year loan or shortening your amortization schedule with additional payments can be a smart strategy.

If you are on a tight budget or want to invest your money elsewhere, the traditional 30 year amortization mortgage makes a lot of sense.

Compare all of your loan options before buying or refinancing a home. And make sure you understand how the amortization affects your monthly payments as well as your home equity options.

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