When you take out a mortgage to buy a home, your monthly payment includes two basic components: principal and interest. Most mortgages have a fixed repayment schedule in which the payment amount stays the same throughout the loan term, but the percentage of the payment going toward interest versus principal changes as the loan is repaid. This is mortgage amortization.
Knowing how your mortgage amortizes can help you keep track of your home equity over time and decide the best way to repay your mortgage, such as by making extra principal payments or by refinancing to a shorter term.
As you compare mortgage terms and interest rates, here is how you can decode your loan’s amortization schedule.
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How Does Mortgage Amortization Work?
When you first buy a home, it can feel like the amount of debt you owe doesn’t budge, even though you’re making payments each month — that’s just the way a mortgage amortizes. Whether your mortgage has a fixed or adjustable rate, you will pay more in interest at the beginning of your loan term, when your principal balance is high.
Later, the bulk of your payment shifts to paying down the principal, says Jordan Benold, certified financial planner at Benold Financial Planning. “Each monthly payment of a mortgage adds more principal until the very last payment, which is almost 100% principal,” he says.
Structuring amortization in this way allows your lender to capture more interest in the beginning of the term. This works in the lender’s favor if you decide to sell the home in the first few years or refinance for a lower rate. It also means that you’ll build equity slower during the first several years of repaying your mortgage, since most of your monthly payment will be going toward interest.
Mortgage Amortization Schedule and Chart
If you’ve been approved for a home loan and signed off on the paperwork, your lender should provide you with a mortgage amortization schedule.
The table below shows a truncated mortgage amortization schedule for a 30-year, fixed-rate home loan worth $400,000 at a 5% interest rate. The monthly payment stays the same throughout the life of the loan at $2,147, but you can see how the portion of the payment that goes toward principal and interest changes over time — especially when you scroll over to the area chart. You can use our interactive mortgage calculator to play with the numbers and download a customized amortization schedule.
You should also be able to sign on to your mortgage lender’s user portal to find all of the information above and more. Some lenders offer calculators that can help you determine how much you’d save by making extra principal payments, while others have tools to help you estimate your home’s equity as you repay the loan.
Why Mortgage Amortization Matters
Your mortgage amortization schedule gives you a forward look into how much you’ll owe on your mortgage as you repay it. You might look at your mortgage amortization schedule to estimate much equity you’ll have based on your remaining mortgage balance in, say, five or 10 years. You use this information to determine how long you’d need to live in a home before it makes sense to move or refinance.
Understanding how your mortgage amortizes can also give you insights into how to pay off your home loan faster. Making extra payments toward the loan’s principal can speed up the amortization schedule and save you money in interest charges. In fact, some homeowners choose to make biweekly payments instead of monthly payments, resulting in one extra payment per year that goes directly to the principal. It may not sound like much, but it could potentially help you pay off your mortgage years faster and save you thousands of dollars over the course of repayment.
Here are a few other things you can learn by getting familiar with your mortgage amortization schedule:
— How interest charges could vary for different loan terms, such as 15-year vs. 30-year mortgages
— How much money you could save by refinancing your mortgage at a lower interest rate
— When you’ll hit 20% equity and may be able to remove private mortgage insurance
Keep in mind that you might be charged prepayment penalty if you pay off your loan before a certain date, which is good to know if you plan on making extra payments or refinancing down the line.
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What an Amortization Schedule Doesn’t Tell You
Your mortgage amortization schedule includes your principal and interest payments, but that’s just a part of your total monthly mortgage payment.
Your lender may also require you to have an escrow account to pay property taxes and homeowners insurance premiums, which are usually rolled into your total monthly payment. While your principal and interest payments stay the same as you repay the loan (assuming you have a fixed-rate mortgage), your taxes and insurance are likely to increase at some point, causing your monthly payments to rise.
In other words, your monthly mortgage payments could go up due to high property valuations or insurance risk, but that doesn’t mean your mortgage will be paid off any faster. You’ll still have the same mortgage amortization schedule and payoff date as when you originated the loan.
Mortgage amortization schedules also won’t show any fees you might pay — for that information, you’ll have to look at your loan estimate or other closing documents from your lender.
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What Is Mortgage Amortization? originally appeared on usnews.com
