Mortgage Amortization Explained: How It Affects Your Payments

Mortgage amortization is a term you should understand whether you’re a first-time borrower or have financial goals beyond homeownership. Understanding what it is and how it works can help you limit the lifetime expenses of your mortgage. Learn what a mortgage amortization schedule is, how to calculate amortization, and how amortization compares to other repayment plans.

What is mortgage amortization? 

“Put simply, mortgage amortization is the process of gradually paying off your home loans over time through monthly payments that cover both the loan amount and interest,” says James Sias, head of mortgage revenue at Fifth Third Bank. 

Some homebuyers are able to purchase a property with cash, but many require financing through a traditional mortgage. Mortgages have set term lengths and either a fixed or adjustable interest rate. Borrowers with either interest rate will owe more interest at the start of their mortgage. 

Each monthly mortgage payment is applied to the interest first then applied to the principal. By the time the mortgage is nearing the end of its term, most of the monthly payment is put toward the principal since the interest is now lower. This process is called mortgage amortization. 

How does mortgage amortization work? 

Lenders create a mortgage amortization schedule when you submit your pre-approval documents, so you don’t have to worry about doing the math yourself. Mortgage amortization works by first factoring in three variables: the outstanding loan amount, the interest rate, and the number of minimum payments you’re required to make over the loan’s term. 

Understanding your mortgage amortization schedule 

Your mortgage amortization schedule can help you budget, especially if you want to pay off your mortgage early or build equity as quickly as possible. Sias suggests paying an additional $200 per month to dramatically reduce overall expenses.

For example, if you have a $350,000 loan with a 30-year term and a 6.5% fixed interest rate, your monthly payment would be about $2,212 and you’d pay about $446,394 in interest alone. However, if you make an extra $200 payment each month, your total interest paid would be $338,304.46, and your loan would be paid off six years earlier.

Here’s what an amortization schedule looks like for a 30-year, $400,000 mortgage with an APR of 6%:

Here’s what an amortization schedule looks like for a 15-year, $400,000 mortgage with an APR of 6%:

How to calculate amortization 

Lenders use the following formula to calculate amortization:

Amortization = i x P x (1+i)n / (1+i)n - 1

In this formula, ‘i’ is the interest rate, ‘P’ is the loan amount, and ‘n’ is the total number of minimum payments in your term. The result ensures that you pay the same set amount consistently each month through the entirety of your loan term.

You can calculate your own amortization before you speak with a lender if you have an idea of how much you want to borrow. For total monthly payments, multiply the term length by months in the year (30 years x 12 months = 360 total payments). For outstanding loan balance, choose a home price (for instance, $280,000) then subtract your down payment (such as $30,000) from it. 

“One factor often overlooked is the total cost of interest on a loan,” says Sias, highlighting the fact that some borrowers budget for a home they can afford month-to-month rather than comparing lifetime loan expenses.

If you assume a 5% interest rate in the example above, you’ll pay a total expense of over $483,000: $250,000 for the outstanding balance and more than $233,000 for the interest alone. 

Tips for using an amortization schedule

Owning a home is a long term investment and prospective homebuyers need to acknowledge that their financial situations may change over the lifetime of the mortgage. Sias encourages potential borrowers to keep these three considerations in mind when using an amortization schedule:

1. Consider the long term versus your monthly budget: Shorter-term loans, such as 15-year mortgages, can save a significant amount of interest over the life of the loan but come with higher monthly payments than a 30-year mortgage. Consider your overall budget, now and in the future, when choosing a loan term.
2. Consider how extra payments can have a snowball effect: Consistently making additional payments on the principal of your mortgage, even as low as $100 to $200 each month, can shorten your mortgage term by years and potentially save you tens of thousands of dollars in interest over the lifetime of the loan.
3. Consider the disadvantages of refinancing: Although refinancing may secure a lower monthly payment, many borrowers don’t understand that a refinance replaces the term on their mortgage, which could lead to the borrower paying even more overall interest on their new loan. 

Keep in mind that you’re allowed to pay off your mortgage loan on the initial schedule. While you will pay significant interest over the loan’s term, many homeowners find it beneficial to have a fixed monthly mortgage payment that enables them to achieve other financial goals.

Comparing amortization with other loan repayment plans

Aside from an ARM, another loan repayment option is an equal principal payment per time period. Whereas amortization has equal total monthly payments that go toward the interest first, this option ensures that an equal payment is consistently put toward the principal, then the interest.

Another loan repayment option is a balloon payment. This involves a mortgage with generally lower payments at the start of the term before ending with a substantial lump sum payment to end the loan. Balloon payments aren’t eligible on loans considered qualified mortgages, though they may be applicable to some homebuyers. This can be a risky option if you aren’t able to pay the large amount when it’s due.