Mortgage amortization is the natural process of building equity in your home by paying off your home loan balance over time with equal monthly mortgage payments. The mortgage amortization process gains momentum over time. When you take out a home loan, initially more of your monthly payments will be applied toward interest (the cost of borrowing money) and less toward the principal balance. As time passes and the loan matures, more of your monthly payment will go toward principal and less toward interest - which means you will gain momentum in the amortization process by building more equity in your home with each payment.
With amortization, even though your housing payment will remain the same, your interest charges will decrease over time and your principal payments will increase over time as you gradually pay off the balance of your home loan.
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How does amortization work?
When you take out a home loan with a fixed interest rate, the interest you will pay will be based on the total amount you borrowed (the principal). When you make your first monthly payment, the balance of your principal will go down a bit. For the next month, the interest you’ll pay will be calculated based on the new, lower balance of your principal.
Each month, although your interest rate percentage will remain the same, you’ll be paying less interest because the balance of your principal will gradually be decreasing. Because your housing payment will be the same each month, more of your money will go toward interest in the beginning, and more will go toward principal as time goes on – until ultimately, you have completely paid off the balance.
What is an amortization schedule?
Borrowers can use an amortization schedule to figure out how much they owe on their home at any point in time. Amortization schedules and calculators are tools that display how much of each monthly payment is being applied toward principal and how much is going toward interest. These tools are based on an amortization formula, and you can generate your own amortization schedule using these steps:
1. For the first month, multiply your total principal balance by your loan interest rate.
2. Divide that number by 12 to get your interest payment for that month.
3. Subtract that month’s interest payment from the total monthly payment.
4. The result is what will be applied toward your principal.
5. Subtract the result above from the total principal balance. Use this value as your new, total principal balance.
6. Repeat steps 1-5 for subsequent months using the new, total principal balance.
Using an amortization schedule can help you compare loans. When you know how much you’ll be paying toward interest and principal over time, you will be able to make a more informed decision on which loan is best for you. This information can help you make informed decisions about your home loan. You may gain insight on whether you want a short- or long-term home loan, whether it makes sense to refinance, or whether it makes sense to pay off the remainder of your mortgage early.
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