Since mortgage rates are expected to continue to rise, it’s easy to focus on your interest rate when trying to lower your payment.
But another factor can have an even greater impact on your monthly mortgage payment: amortization.
Amortization is the period over which you repay a loan. For most mortgages, this will be 30 years or 15 years. This affects how much interest you pay over the life of the loan and how quickly you’ll increase your home’s equity, says Scott Nguyen, licensed real estate broker and owner of Made Mortgage, an Oakland-based mortgage brokerage firm. in California. It’s also the stabilizing force that can keep the principal and interest portion of your monthly payment fixed for the duration of the repayment period, Nguyen said.
But not all loans are fully amortized, which has its pros and cons. With interest rates rising this year, it’s important to understand how your loan amortization schedule affects your financial future.
What is amortization?
Amortizing a loan is the process of determining the monthly payments needed to pay off the balance within a certain period of time. For example, a 30-year mortgage will be paid off in full after making payments for 30 years. On a 30-year fixed interest rate loan, you’ll typically make the same monthly mortgage payment every month for 30 years.
While each monthly payment may be the same amount, it’s important to understand that with each mortgage payment, different amounts may be allocated to principal and interest, says Mai Huynh, underwriting manager at online mortgage lender Better. .com. “On a brand new loan, the majority of your payments will go toward interest. And the longer the term of the loan, the more interest you will pay over the term of the loan.
If you can afford larger payments, a shorter loan term can save you tens of thousands of dollars over the life of the loan.
An amortization schedule shows how each payment on a loan is applied to principal and interest. Understanding how to read an amortization schedule can be especially helpful for buyers who need to consider private mortgage insurance (PMI), Nguyen says. The PMI can usually be removed once a homeowner has 20% of their home’s equity, he said. With an amortization schedule, owners can see exactly when they can request removal of PMI and plan for additional monthly savings.
Which loans are amortized?
There are many different types of loans, and not all of them will be repaid at the end of the loan term. These types of loans are called amortization loans.
Although monthly installments on an unamortized loan do not pay off the entire loan balance, they have certain advantages. You might have lower or zero monthly payments, but you might have to offer a lump sum payment at the end of the loan.
Here are some types of depreciable and non-depreciable loans.
Conventional Fixed Rate Mortgage: A typical fixed rate conventional loan will have equal monthly payments over a specified period of time, usually 30, 20, 15 or 10 years. This is considered a secured loan because your home is secured if you fail to repay the loan.
Adjustable rate mortgage loan: An adjustable rate mortgage (ARM) usually offers lower introductory rates than a fixed rate mortgage, usually 1, 3, 5, 7 or 10 years. Although changing interest rates may affect the amount of monthly mortgage payments, making regular, timely payments will still pay off the loan balance at the end of the loan term.
Automatic loan: A car loan is similar to a mortgage, but a vehicle is collateral instead of a house. Auto loan payments are usually equal monthly amounts paid over 3 to 7 years.
Personal loan: Borrowers can use personal loans for just about any reason. These loans usually have higher interest rates since they are unsecured loans.
Home Equity Line of Credit (HELOC): A home equity line of credit (HELOC) is like having a credit card backed by the equity in your home. A lender gives you access to a line of credit based on the equity in your home, and you can draw on that line of credit for a certain period of time.
Loans without amortization
interest only loan: With an interest-only loan, borrowers can benefit from lower monthly payments because payments will only cover the interest portion of the loan for an interest-only period.
balloon mortgage: Balloon loans have either no monthly payments or lower monthly payments than conventional mortgages. At the end of a specified period of time, however, a borrower must repay the loan with a lump sum payment.
Deferred interest loan: Deferred interest loans allow the borrower to avoid paying interest for a fixed period. Usually, if the loan is repaid before the end of this period, the borrower will owe no interest. However, if the loan is not repaid, interest will start to accrue.
Amortization vs Depreciation
Depreciation and depreciation are similar concepts, but there are differences. With an amortization schedule, payments are designed to reduce the loan balance to zero after a certain amount of time. With depreciation, the value of the asset is reduced over a specified period of time.
Simply put, assets depreciate as their useful life is reduced. For example, cars that have been driven for several years depreciate in part because they are not expected to last as long as a new car.
Houses can also depreciate with normal wear and tear. But the increase in home values can exceed the depreciation. Homeowners can keep their property value high by being proactive with preventative maintenance, repairs and renovations.
Examples of Asset Impairment
- Mobile phones
How to read an amortization schedule
Let’s walk through an example of how to read an amortization schedule for a mortgage loan.
Using this mortgage amortization calculator, enter a purchase price of $350,000, a down payment of 10% and a 30-year loan at an interest rate of 4.7% on the side left.
- In the “Payment Breakdown” tab, you can see that the monthly principal and interest payment is $1,633.
- The “payment breakdown” section also allows you to enter your monthly home insurance, property tax, and HOA fees.
- In the “amortization schedule” tab, you can see how each payment is split between principal and interest. For example, the first monthly payment of $1,633 has $399.25 applied to the principal balance, while $1,233.75 is applied to interest.
- With each subsequent monthly payment of $1,633, more is applied to the principal of the loan.
On the left side of the amortization schedule is the date of each payment. This gives you the ability to see the exact loan balance on each date and allows you to easily see when you can get rid of the PMI.