When applying for a mortgage, the word “amortization” will come up frequently. Amortization is the most misunderstood term people encounter when applying for a mortgage to purchasing a home. This blog will break down what amortization means and provide a better understanding as it relates to your mortgage.
The monthly mortgage payment will be determined by three things: Loan balance, Interest rate and term of the loan. Repayment of the loan is done with monthly payments. Part of the payment goes to reduce your loan balance(Principal) and part goes to pay the interest due. Technically, you should have a higher payment in the beginning when your loan balance is biggest and smaller at the end when it is smaller. However, most people prefer a consistent monthly payment that is the same every month, and this is where amortizing comes into play.
Simply put, loan amortization is a way to equalize the monthly payment over the life of the loan. Based on this calculation what is paid every month will stay consistent, but the portions going towards principal and interest will change over time. In the beginning more of the monthly payment goes towards interest and as each payment is made it reduces the principal loan balance resulting in more of the monthly payment going towards the principal.
The mortgage lender will provide a loan amortization schedule which will give a full breakdown of the monthly mortgage payments from today until the end of the mortgage term (i.e. 30 year term). The amortization schedule will show how much of the monthly payment will go toward principal and interest. It will also show the total interest paid, and the remaining loan balance left.
The easiest way to see the breakdown of the monthly mortgage payment is to use a mortgage calculator. Here is a quick overview of what that calculation would look like.
If the loan amount is $300,000.00 at a 4.50% interest rate for 30 years. The monthly payment for principal and interest would be $1,520.06
Below is how to calculate what portions of the payment go toward principal and what portion would go to interest.
Take the principal balance of $300,000.00 Multiply it by the annual interest rate of 4.50% then divide it by 12 months
That will give the portion of the monthly payment that goes toward interest=$1,125. The remaining amount of the payment $395.06 will be applied to principal
Total Payment = $1,520.06
Principal = $395.06
The new principal balance would then be used for the calculation of the next month’s distribution of principal and interest. This process will repeat every month until the balance reaches zero or at the end of the term.
Paying down the principal balance, in the beginning, will greatly accelerate the payoff process and save a lot of money in interest. Try making one extra full principal payment each year, will shave off a few years off on the mortgage.
If you want to know what the calculations would look like for your scenario or would like to explore with our app, please reach out to the Five Star Mortgage Team today!