Homeowners

Understanding the Mortgage Amortization Schedule Can Help Homeowners Save Money

After you purchase your first home, and the excitement wears off, you may begin thinking about how long it’s going to take you to pay off that large sum of money you just borrowed.

This is where mortgage amortization enters the picture. 

Amortization is the process of gradually repaying your loan through regular, equal payments over time. 

As part of your loan process, you’ll receive what’s known as an amortization schedule. It’s a document that shows how much you’ll pay each month over the life of your loan and how long it will take for you to pay it off.

Looking at your amortization schedule may seem intimidating. However, once you understand your loan, you can consider if there are ways for you to save money over time. One option that could make sense for you to make extra payments. 

In some cases, those additional payments may shave years off the life of your loan. They may also save you thousands, if not tens of thousands of dollars, in interest charges. 

So, what do homeowners need to know about amortization?

What is a mortgage amortization schedule

When you borrow money for your mortgage, you will be responsible for paying off two things over the term of your loan:

●      Principal: the amount of money you borrowed

●      Interest: the fee you pay the lender for borrowing that money

Say you take out a $400,000 mortgage with a 5% mortgage rate. The principal is $400,000. You’ll also pay an additional $20,000 in mortgage interest each year for borrowing the money.

Your monthly mortgage payment will include a portion that covers your principal balance and a portion that covers the interest.

The mortgage amortization schedule “essentially breaks out how much interest versus how much principal you're going to pay as a borrower with each one of those payments,” said Rick Sharga. He is the CEO of CJ Patrick Company, a market intelligence and advisory firm specializing in real estate.

What many first-time homebuyers don’t realize is that at the beginning of their mortgage term, they will be paying more in interest, since their loan balance is still high.

That means they aren’t building as much equity in their first years of homeownership. 

“Early in your payments, early in your mortgage, you're going to be paying a higher percentage of interest than principal,” said Sharga. “As you get closer to the end of your mortgage, you're going to be paying almost entirely principal and very little interest.”

The longer the term length of your loan, the more money you will pay in interest. However, there are solutions if you’d like to pay less in interest over time.

How can making extra payments help you pay off loans sooner

Many homeowners don’t realize that making extra mortgage payments on their loan can help them pay off their mortgage faster—and reduce the overall amount of interest they pay for borrowing the money. 

In other words, they may be able to save thousands, if not tens of thousands of dollars, by making extra payments.

New American Funding loan officer Brenda Robinson, based in Inglewood, Calif, recommends borrowers make an extra mortgage payment a year and put it toward their principal. 

“Then you’ll be able to pay the loan off sooner,” she said. “Not only are you building equity, but now you're shorting the time span for your loan.” 

Borrowers can also consider paying their mortgage every two weeks instead of every month. This adds up to the equivalent of an extra month’s payment every year. 

Or they can pay about 1/12 more every month and apply that to their principal, suggested Robinson. This way it may be more financially manageable for them. 

For example, if your mortgage payment is $2,000, divide it by 12. Then add that extra $166.67 each month to your mortgage payment, applying it to the principal. If you just apply it to the regular payment, it will also go toward the interest and you won’t pay down the balance as fast. 

Of course, homeowners should consider their personal finances in considering whether they can afford those extra payments.

How can refinancing your loan affect your amortization schedule 

With mortgage rates coming down in recent months, some homeowners may be looking to refinance their existing loans to a lower rate or switch from an adjustable-rate mortgage to a fixed-rate mortgage. 

Refinancing to a lower interest rate can help lower your monthly mortgage payments, saving you money in the long term. However, you will likely be charged closing costs to do so. And you’ll restart the amortization process again, potentially extending the repayment period of your loan as well.  

And in the early years of this new loan, you will be paying off more of the interest than the principal.

“I tell clients if you need to refinance take into consideration [if] you want to pay it over 30 years. Maybe you want to go down to a 25-year [loan,]” said Robinson. “That’s going to speed up when [you] pay the loan off.”

Brenda Robinson NMLS # 954742