BOULDER – When we discuss mortgage amortization in the context of home loans, we are simply referring to the process that causes the amount you owe to decrease with time. This debt repayment happens in monthly installments, with a portion of your payments going toward interest and the remaining funds being used to reduce your loan’s principle balance. As part of the mortgage process, you will be given an amortization schedule, which provides a breakdown of how this works, including month-by-month details of how your payment is being allocated. These numbers change over time, so pay attention to the amortization schedule that you are given; it contains some very valuable information.
When you take out an amortized loan of any kind, the payments that you make in the beginning consist mostly of interest. Later in the life of the loan, the majority of your payment is being used to pay down the principle balance. These dynamics affect how quickly you are able to build equity in your home. This is why we often hear finance gurus and homeowners discussing the benefits of making extra principle payments whenever possible throughout the year. Those extra payments are one way that homeowners have of controlling the rate at which their principle balance is paid off and the amount of interest they pay over the life of the loan.
Assuming the mortgage does not have any provisions that forbid or penalize you for prepayment, this system works out quite well for those who are disciplined enough and able to make larger or extra monthly payments. An even better strategy is to choose a shorter amortization schedule in the beginning. A shorter amortization schedule means that your payment will be higher, but you will have the benefit of paying off the loan sooner and saving a considerable amount of money on interest. Also, as demonstrated by the data below, another advantage is that consumers are often able to obtain lower interest rates when they choose the shorter loan.
To give you an idea of just how dramatically this strategy can affect your mortgage payments, here is what your monthly obligation will look like with a 15-year, 20-year, and 30-year loan, if you borrow $300,000.00*:
• 30-Year Fixed, 3.875% (Points and APR: 0.73/3.99%)*
• Total interest $211,611,
• PI payment $1406.96
• 20-Year Fixed, 3.625% (Points and APR: 0.90 /3.79%)*
• Total interest $126,475
• PI payment $1753.96
• 15-Year fixed, 3.00% (Points and APR: 0.90 /3.22%)*
• Total interest $77,179
• PI payment $2067.67
*All of the above scenarios assume a $300k purchase loan, 760 FICO, 20% down payment, single family residence, 25-day lock. Rates are estimates and subject to change
Keep in mind that this does not include your taxes or insurance. These figures vary based on a number of factors (especially the location of your home), and your payment will be higher once these have been accounted for.
If you can comfortably manage the higher payments, choosing a mortgage with a shorter amortization schedule is a wise decision, but be sure that you are confident in your ability to maintain that level of payment for the entire 15 years. For some, a 20-year mortgage is a more reasonable compromise, offering somewhat quicker repayment and lower interest, without causing such a drastic increase in the amount that is paid each month.
Fortunately, you don’t have to make these decisions on your own, and I am happy to be a resource for anyone who is interested in purchasing a home in the near future. If you have questions about amortization schedules, or any of the other details associated with mortgage loans, please contact me at email@example.com.
Michaela Phillips is the Vice President of Mortgage Lending at Guaranteed Rate, Inc., the 8th largest retail mortgage company in the country. Since entering the mortgage industry in 1994, she’s consistently been a top producer. Being a VP at Guaranteed Rate offers many advantages to her and her clients including unparalleled customer service, efficiency, and most importantly competitive rates. NMLS: 312874