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What is Amortization? How Your Monthly Payment Breaks Down Over Time

By Thomas O'Shaughnessy | September 28, 2023

Buying a home is one of the most exciting and challenging times in a person's life. But when you get the keys to your first house, there’s something you need to understand before you start picking out your new furniture: that home you just bought isn’t technically yours. It belongs to the bank until you pay off the mortgage, which happens more slowly than you might like. Your payment goes to principal and interest each month following an amortization schedule. Here’s how your monthly payment breaks down over time — and what that means for you.

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What is amortization?

A monthly mortgage payment includes principal, interest, and other fees such as property tax and private mortgage insurance (PMI). Although property tax and PMI are relatively stable over 12 months, the balance between your principal (the amount of money you borrowed from the bank) and your interest (what that money costs you) changes. This is called amortization — a process of breaking down loan payments over time.

Unlike interest-only loans, variable rate loans, or loans with a balloon payment at the end of the terms, amortizing mortgage loans are designed to be paid off in a fixed period. To do this, lenders calculate interest rates over the loan's full term so you know exactly how much your monthly payment will be and what part of it will go to your loan balance. 

First-time home buyers may not understand that they only own the equity — not the home. And this is how it is until you send in that last mortgage payment and get the deed with your name on it. But you own a higher percentage of your house as time passes and the amount you owe on the principal shrinks.

How does amortization work?

When you get your closing documents, your lender will include a detailed breakdown of your monthly payment. This is the amortization schedule for the life of your mortgage. It shows you exactly how the payment is divided between principal and interest and how much you owe after each payment.

If those documents aren’t close at hand, it’s easy to calculate how your interest and principal are applied.

Take this example. Using a simple mortgage calculator for a $210,000 house with $10,000 down and an interest rate of 7% shows a monthly mortgage payment of $1,331. Here’s how to find the amount of your payment going towards your principal in the first year:

  • $200,000 (principal balance) x 7% (interest rate) = $14,000 (current annual interest fee)
  • $14,000 (current annual interest fee) / 12 (months) = $1,167 (current month’s interest fee)
  • $1,331 (monthly payment) - $1,167 (current month’s interest fee) = $164 (current month’s principal payment)

Early in the life of your loan, the biggest percentage goes towards interest. This can discourage new homeowners when they see how little progress they are making on their principal. But that balance shifts over time as the life of the loan progresses.

The life stages of an amortized loan 

Following is a basic outline of the life stages of an amortized loan. Keep in mind that your specific payment timeline can be shortened. For example, paying extra principal early on can be a great way to minimize the amount of interest you pay and can even help you pay your mortgage off early.

In general, though, here’s what to expect.

Early life 

In the first ten or so years of your loan, most of your monthly payment goes towards interest. This is the most expensive stage of your mortgage. This is why real estate investors buy houses with cash when planning on re-selling. They skip interest altogether — which is especially important in this first phase.

Midlife

Payments start to become more balanced in the middle portion of your mortgage. The amount of principal gradually increases, and as you pay that balance down, the interest decreases. 

The golden years

In the last years of your mortgage’s life, the vast majority of your payment goes towards the principal. Watching your loan balance shrink rapidly can be very satisfying at this stage.

Amortization

The amortization schedule tells you how long it will take to pay off your loan, but that doesn’t mean it isn’t subject to change. If you refinance your mortgage (with the same lender or a different one), the amortization clock starts over. Refinancing might be worth it if interest rates drop dramatically and you can have more manageable payments.

Pros and cons of an amortizing loan

It can be a cold shock to realize that the first decade of your mortgage payment goes more toward interest than toward actually owning your home. Sure, you can put your buyer rebate towards the principal to jump-start your equity, but seeing the bottom line so far away can be daunting.

If this seems discouraging, weighing the pros and cons of amortizing loans is good. 

Pros of amortizing loans

These loans are very predictable. They allow you to set a budget and stick to it, knowing that your housing cost will remain stable over the years. You also know exactly when your last payment will be.

Amortizing loans also build equity. It may be slower than you’d like, but it does build. This is more than you can say for staying in a rental property. Even if the rent never goes up for 30 years, in the end, you will have nothing.

Cons of amortizing loans

The biggest disadvantage is the front-loaded interest. For a 30-year mortgage, paying so much interest and so little principal can feel like treading water.

And a fixed monthly payment may be challenging for people who don’t have a regular income. This is most challenging for those with a big paycheck one month and a tiny one the next. A budget is critical in this case, but the same applies to any kind of mortgage.

Is an amortizing loan right for you?

Amortization schedules give homeowners a clear picture of how much money they are borrowing, how much it costs, and the repayment schedule. This may seem complex, but in the end, it sets out a very specific timeline and a path to home ownership.

If you aren’t sure what type of loan is best for your situation, talk to your lender. They can outline all the options you qualify for and give you an idea of what repayment plan might work best for you.

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