Amortization is the prevalent method of paying the principal of a loan back on a predetermined repayment schedule.
When you pay your mortgage each month, you pay principal and interest on the amount that you borrowed. The principal payment goes toward paying down the outstanding balance of the loan. The interest payment goes toward paying for the cost of borrowing the money. Every time a borrower makes a payment toward the principal of a loan, amortization is happening.
Principal and interest payments are not the exact same amount each month.
The amortization schedule outlines the amount of principal and interest a borrower pays on each payment. Schedules have a structure so that the final payment within a loan term will completely pay off the loan. Using Lyons’ Payment Schedule Calculator, below is a year-by-year amortization schedule of a $100,000 mortgage with a term of 30 years and a 4% interest rate:
Monthly Breakdown of Year 1:
Notice in the Monthly Breakdown that the total payment is the same each month. The allocation toward principal and interest are what changes. It is common for the interest payment to be higher than the principal payment at first. As you can see, this starts to change as time goes on. More principal gets paid monthly than interest in the latter stages of the loan term.
Understanding how amortization works will help you make the best choice when you need to get a mortgage.
Take advantage of our Payment Schedule Calculator to determine how much of a monthly payment you can afford. If you are a first-time homebuyer, consider whether a 15 or 30-year term makes the most sense. If you already have a mortgage, use the calculator to see if refinancing is a good idea. Using this tool will also show which options save as much interest as possible, creating long-term savings.