For most people, buying a home is the biggest purchase they’ll ever make. It’s natural to have questions about the process in general, as well as specific questions about payments, equity, and other issues.

SIRVA Mortgage specializes in guiding people through the process of applying for and closing on a mortgage. One of the things we get asked about frequently is mortgage amortization, which can be confusing if it is something you are not familiar with. In this post, we’ll break down the basics of mortgage amortization schedules and give you some tips on how to accelerate amortization if that’s something you want to do.

What is Mortgage Amortization?

Let's start with a definition of mortgage amortization. Simply stated, it's a term that describes exactly how the loan balance is paid down over the term of the mortgage.

Mortgage loan amortization can be confusing for some people because, when they look at the payment schedule, each payment is the same amount. However, early in the mortgage term, most of your monthly mortgage payment goes toward interest. Very little of the payment is applied to the loan principal, which means that your principal balance won't change much at first.

Over time, as the principal balance decreases you are charged less interest on that remaining balance each month, which means more of your monthly loan payment will be put toward the principal of your loan. As it does, you will gain equity in your home.

The term fully-amortizing loan means that the principal loan balance is paid in full at the end of the loan term if all payments are made as scheduled, thus the term amortization schedule. It is common for lenders to use the word amortization as a synonym for the loan term when talking about a fully-amortizing loan. 

While it's rare, there is such a thing as negative amortization. It happens when a lender offers a borrower the chance to pay only part of the interest due each month. The unpaid interest is added to the principal and the borrower ends up paying interest on the interest. Over time, your debt will get bigger instead of smaller.

The most common amortization term for a mortgage is 30 years. If that's the term you choose for your mortgage, it will take 30 years to amortize the loan, or pay it in full, unless you accelerate the amortization by making extra payments towards the principal balance.  

Example of Amortization

Mortgage amortization is complicated, and unless you’re an expert or mathematician it may be confusing to understand how it works. Even if you use a mortgage calculator to see how your monthly payments are broken down into interest and principal, you may still have questions.

To help explain the concept, here's a condensed amortization table to show how amortization works over time. For this example, we've used a fixed rate mortgage of $400,000 with a 3% interest rate and have broken down the term into several chunks of payments.

As you can see, the early payments are heavily weighted toward interest and not a lot is applied to the principal. This is because the 3% interest is being charged on a higher loan balance.  As the principal loan balance slowly decreases, the amount of interest being charged thereby decreases, which means more of the payment is applied towards principal. By the time Month 96 of the mortgage term is reached in this example, the payments are weighted slightly more toward the principal and it's at that point that the balance shows more movement and equity is gained more quickly. As you can see by the chart, the balance in month 96 is almost $74,000 less than in the first months of the loan. That means that the 3% interest you would have been paying on that $74,000 is now going towards principal.

With a shorter amortization period, the monthly payments would be higher but they would also be more heavily weighted toward principal from the beginning. For example, using the same beginning loan amount and interest rate we used above, for a 15-year term the monthly payment amount would be $2,762.33 with $1,762.33 initially going toward the principal. The monthly payments are higher than they would be with a 30-year amortization but far less in interest is paid in total over the term of the loan.

It should be noted that this is only an example. There are many things that can impact amortization, including the beginning loan amount, interest rate, the term of your home loan, and other factors.

Mortgage Amortization and Equity

One of the things that many homeowners don't know about amortization is how slowly it happens. After reviewing the amortization example above, you'll have a better understanding of how it works.

Assume the house in question was purchased for $500,000 and the buyers made a $100,000 down payment. They would not reach 50% equity in their home until they were approximately halfway through the amortization period, even though the starting loan balance was only $400,000. That's because principal repayment is slower at the beginning of the term. The regular principal and interest payment you make each month is mostly paying interest at first.

The amortization becomes even more stark with a lower down payment. With a 3% down payment, the payment would be higher each month and it would take close to 18 years for the homeowner from our example to reach 50% equity.

Equity in your home builds wealth and allows you to borrow against your home’s value in the future. As your mortgage is amortized your outstanding debt decreases as well. For many homeowners, building equity quickly is a priority.

Can You Accelerate the Amortization of Your Mortgage?

There are several strategies you can implement to accelerate the amortization of your mortgage and save money on interest.

Shorter Mortgage Term

The first amortization acceleration method is something we have already mentioned. If you opt for a shorter mortgage term, your mortgage payment will be significantly higher than it would be for a longer term. If you look at the example above, the payment for a 15-year term is more than a thousand dollars higher than the monthly payment for a 30-year amortization. 

The trade-off for the total monthly payment going up is that with a 15-year mortgage you will pay far less in interest and will gain equity far more rapidly than you would with a 30-year mortgage. If you can afford a higher monthly payment, this may be a good option for you.

Accelerated Monthly Payments

Some borrowers choose to accelerate the amortization of their mortgages by making accelerated payments. Many lenders will allow borrowers to add additional money to their monthly payments to pay down the principal of their loan.

There are several ways to make accelerated payments. You could pay a little bit extra toward the principal each month, or sometimes people who are paid biweekly use their two “extra” paychecks each year to put toward their mortgage. You also have the option of making a lump-sum payment toward the principal if you receive a bonus or a large tax refund.

Refinancing

The final amortization acceleration method to consider is refinancing. Sometimes, homeowners can refinance their homes with better loan terms to save money. If you can lower your interest rate by even one percentage point, you can save a lot of money over the term of your mortgage.

Another option would be to refinance for a shorter term. If you have more monthly income now than you did when you bought your home, you can shorten the term (and possibly lower the interest rate, too) to save money and accumulate equity quickly.

A SIRVA Mortgage licensed Mortgage Consultant can review your financial situation and your current loan terms to help you determine whether refinancing into a new mortgage loan is the right option for you.

Conclusion

Whether you’re preparing to apply for a mortgage for the first time or you’ve owned a home for a while, learning how mortgage amortization schedules work can help you save money on interest payments and gain equity in your home more quickly than you would otherwise.

At SIRVA Mortgage, we’re here to help our existing borrowers and new borrowers to understand all available mortgage options and walk them through every step of the process. Click here to get started.