What is mortgage amortization?


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What is Mortgage Amortization?

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What is mortgage amortization?

  1. 1. Good and Bad News on AmortizationWhat is mortgage amortization?Amortization is the repayment, systematically, of calculated principal and interest to a lender over adesignated period of time. A loan amortization schedule will help provide a timetable for paying theinterest and principle on your loan. And if youre considering a home loan, your lender should be able toprovide you with amortization schedules for different financing scenarios.Amortization will also help youdecipher how much your monthly payments will be during the term of your and give you a look at thebigger picture of exactly how much your loan will cost you including interest.A mortgage of $200,000 will require nearly $350,000 in monthly payments over a 30 year period.Anything you can do to shorten the term can save a lot of money.To determine Amortization you willneed your interest rate, loan amount (principle), and your term. Calculating an amortization schedule isa not an easy task. Amortization is the built in payoff calculation contained in most mortgages.Amortization is your best tool in the process of getting your loan paid off. Amortization, simply put, isthe difference between your monthly Utah Mortgage payment and the interest portion it contains.Thankfully, some really smart mathematical whizzes came up with tools that do it for us automatically.You can just punch in the numbers and print out a schedule. You can find online tools to assist you ifyoure sitting at home and curious to see your current schedule. Or sift through your folder of loanclosing documents. You should be able to dig up up a copy.By making prepayments on your mortgage,either by increased monthly payments or by periodic lump sum payments, you decrease the amountyou owe and the monthly interest payment.Amortization SchedulePages and pages of numbers that finally end up reflecting your loan balance paid off. It points out toyou, payment by payment, exactly how much of your monthly loan payment is directed toward principalreduction, lender collected interested, and escrow payments (if you have your lender pay your taxes andinsurance for you). Also, you can see on the Truth In Lending statement just exactly how much moneyyoull be paying out of pocket over the full amortization period if you only make your minimum monthlypayments. Its enlightening. Or some say, nauseating. The fact of the matter is that 85% (or more) ofyour house payment on the first pages of the amortization schedule go mainly toward interest fees. Itsnot till the back few pages that your payment really starts chipping away at principal.So how can you avoid paying so much more money back to a lender than youre actually borrowing? Bymaking extra principal payments monthly. You may be surprised to know that by paying additionalmoney towards principal monthly, (make sure to write a separate check and mark it "principalpayment"), you can chip off years of your loan repayment schedule and keep money in your pocket. Forinstance, if you have a 30 year fixed mortgage for $150,000 at 6%, paying an extra $50 per month willsave you $26,673 in interest and pay off your loan approximately 4 years early. You can also achievesimilar results by making a lump sum principal payment a year (maybe budget part of a yearly bonus
  2. 2. toward this goal). Why this scenario works is that by reducing the principal more quickly over time,theres less of a lump sum debt to calculate interest against. Make sense?Purposes of Negative AmortizationThe disadvantage of negative amortization is that the payment must be increased later in the life of theUtah Mortgage. The larger the amount of negative amortization and the time-consuming over which itoccurs, the larger the increase in the payment that will be needed later on to fully amortize the loan. Inhistory, the major purpose of negative amortization has been to reduce the mortgage payment at thebeginning of the loan contract. It has been used for this purpose on both fixed-rate mortgages (FRMs)and adjustable rate mortgages (ARMs). A second purpose, applicable only to ARMs, has been to reducethe potential for payment shock -- a very large increase in the mortgage payment associated with anincrease in the ARM interest rate.Mortgage Amortization FormulasRunning these formulas in Excel ought to allow you to route pretty much any mortgage scenario thatyou are considering. 1. To calculate the mortgage payment amount, use this =PMT(rate,nper,pv) 2. To find out how much interest would be paid over a certain number of months, use this formula =ISPMT(rate,per,nper,pv) 3. To get the total amount paid in interest between two given months, use =CUMIPMT(rate,nper,pv,n1,n2,0) 4. To figure out the number of payments that will be made, use this one =NPER(rate,pmt,pv) 5. To find out the total amount paid in principal between two given months, try =CUMPRINC(rate,nper,pv,n1,n2,0)Variable Keys for the Formulas 1. per: specific period of time, usually expressed in terms of number of months 2. n1, n2: specific period in terms of ordinal month number 3. rate: interest rate per period 4. pmt: the payment amount per period, which is most commonly the monthly payment 5. nper: the number of payment periods 6. pv: the present value of the loan
  3. 3. InterestThis interest is usually shown as an annual percentage rate calculated by your lender. In a sense yourlender is investing in whatever you are using your loan to fund, and so expects a return on thatinvestment in the form of interest. Taking care of your credit and being smart with your finances canreally help insure that you qualify for the lowest interest rate possible.Your interest rate can be affectedby a host of different things. Lenders can take into account your credit and payment history, debt toincome ratio, employment history, size of down payment, and the amount of money you plan to borrowinto calculating your rate.PrincipleYour principle is the exact amount of money that you plan to borrow without the interest taken intoaccount. You should never borrow more than you can afford especially considering that the higher theprinciple, the longer it will take to pay off your loan, and the more interest that will accrue on yourbalance.Loan TermA repayment term tells you how long you will have to pay back the debt to your lender. The longer theterm you choose to pay your loan over, the longer your loan will be collecting interest. This means thateven though spreading your payments over a longer period of time may lower your monthly payments,you will also be paying substantially more on your loan in the form of interest. Interest can add up quitequickly so its important to balance your interest rate with your terms. 1. Simple Interest Mortgage Amortization The interest is based on the balance of the day of payment on a simple interest mortgage, which is calculated daily. If payment were made on the first day of every month in both cases, it would come out the same over the course of a year. However, if a payment were late staying within the usual fifteen-day grace period under the standard mortgage scheme, one would do better with that Utah Mortgage. 2. The Fully Amortizing Payment on FRM and ARM The fully amortizing payment is the monthly mortgage payment that will eventually pay off the loan at term. On a fixed rate mortgage (FRM), the fully amortizing payment is calculated at the outset and remains constant over the life of the loan. On the other hand, on an adjustable rate mortgage or ARM, the fully amortizing payment is constant only when the interest rate remains constant. The fully amortizing payment changes only when the rate changes. 3. Standard Mortgage Amortization In a standard mortgage, tax and insurance payments are shown in the amortization schedules, if made by the lender and the balance of the tax or insurance escrow account. Strict and rigid rules apply in the payment requirement regarding the standard mortgage. Even if a single payment is missed the late charges accumulate until the payment is made up.
  4. 4. Using your principle, interest, and loan term you can then calculate exactly how much your monthlypayment will be each month. This is why its so important to understand the amortization process sinceyour amortization will give you the big picture of the life of your loan. Amortization will help you seehow paying larger monthly payments can help pay off your principle balance quicker, meaning that youwill also pay less interest in the term of your loan. It can also help you determine whether you truly canafford the monthly payments of your loan. Understanding loan amortization truly will save you a lot ofmoney when you take it into account while calculating your monthly payments.A Look at Refinancing and AmortizationIf you’re fifteen years into a 30 year loan, and you refinance back to another 30 year loan, your newpayment will be lower, but you’ll attain that by beginning the amortization process all over again. Thebest course to follow if you want to keep yourself on the original payoff schedule is to set the term ofthe new loan to no more than the number of years you have remaining on the old Utah Mortgage, or inthis case 15 years.Amortization is something of an strange term, but you don’t have to shy away from it. What it basicallymeans is your loan was set up in a way that will take a specific amount of time to repay it. Skip out onspending money where you don’t need to. Put the money toward your principal. Or when pre-qualifyingfor a home, include an extra principal payment in your budget. Lower your "payment comfort level" atad to allow for an extra monthly principal payment you intend to make. Amortization is a slow process,which is why it’s so important to begin pre-paying your mortgage as early in the term as possible. Youllreally see the benefit of doing so in the long run!