Amortization is the reduction of a home mortgage by making payments to both the principal (what you originally borrowed) and the interest in differing ratios over the period of the loan. Your amortization schedule will break down how much of your monthly payment is applied to the principal balance and how much is allocated to the interest. You will pay more interest in the beginning of the loan, while you agree to pay more in principal towards the end of you loan, since the interest is paid off first and the principal is paid off last.
How Does Amortization Work?
So, how does amortization work? Its actually quite simple. The monthly principal and interest payment will always be the same amount, and broken down by interest and principal, with the majority of the payment going to interest for a while. However, the total debt will be reduced by the amount applied to the principal. Then, when the next month rolls around, you will only owe interest on the new debt amount. The same payment will be made, and this time a bit more of the payment will go the principal. This will occur monthly until the majority of the payments are applied to the principal and the interest is greatly decreased, while your equity increases.
How Amortization Can Benefit You
The primary advantage of amortization is that each loan payment will increase your amount of equity in your home. And, if you have a fixed interest rate loan, your monthly payment amount will never vary. Also, by making slight over-payments each month, you will amass equity much faster and significantly decrease interest (since extra payments will be applied straight to principal). Sometimes an overpayment of $50 a month can shave up to two years of interest payments off your loan (depending on your terms).
How Amortization Can Work Against You
Homeowners that choose to continuously refinance their loans are especially vulnerable to paying more in interest. That is because each time they refinance, they will find themselves in the beginning stages of amortization again, and again paying heavy interest. If the going interest rate is significantly lower than the terms of your loan, refinancing may still be a good option for you, however, an extended amortization period can still negate any benefit you may receive from refinancing.
Do you have questions about your amortized home loan or your amortization schedule? Contact a knowledgeable mortgage broker such as Gerry Orr at (403) 249-9650 to learn more about saving money on your mortgage today.