Understanding An Amortization Schedule

When you take out a mortgage, you are agreeing to pay back the amount you have borrowed along with interest, over a set period of time.Coins

We’re going to address the typical 30 year fixed principal and interest loan program for this particular article about an amortization schedule.  Most of the time, mortgage payments also include an amount for property taxes and property insurance and sometimes for mortgage insurance.  To keep it simple, lets just talk about a payment that does not include these items.

On every payment made, a certain amount of it is applied to the interest first and then the rest is applied to the principal balance.

Since the amount of interest charged is based on the balance that is owing, more interest is charged at the beginning of a loan than there is at the end.  Over time the amount of interest charged decreases and the amount of your payment going to the principle balance increases.

To get a visual of this process, take a look at this example loan and it’s loan amortization chart.


In this example, they took out a $100,000 loan at 7.5% interest rate, fixed for 30 year term.  The payment needed to pay the loan off in 30 years, would need to be $699.21 per month.  In the first month, you owe $100,000, which means the interest would be calculated on the full loan amount.  The interest in month number one would be $625.  So if the payment is $699.21, then $625 goes to interest and $74.21 goes to pay down the principle balance.  The balance in month #2 is now $100,000 minus $74.21 = $99,925.79.

In month #2, you make the same payment of $699.21.  However, this time, you now owe $99,925.79.  Therefore, you will only pay interest on $99,925.79.  The interest owed in month #2 is $624.54. (slowly decreasing)  The remaining $74.67 will be applied towards principal. (This amount is increasing!)

Every month, the same simple  calculation will be made. Because the payments are remaining the same, each month the interest will continue to be reduced and the remainder going towards principal will continue to increase.

An amortization chart runs you through this process until you get to the final payment. The chart can also be a useful tool to determine interest paid to date, principal paid to date, or remaining principal.

Another frequent use of amortization charts is to determine how extra payments toward principal can affect and accelerate the month of final payment of the loan, as well as reduce your total interest payments.  You can save a ton of money by just making a little larger payment every month.  Talk to your mortgage professional about this and running an amortization schedule for you!

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