What is amortization? How a mortgage amortization schedule works

Erik J. Martin
The Mortgage Reports contributor

What is mortgage loan amortization?

“Mortgage loan amortization” is the process of paying a home loan down to $0. 

A mortgage — or any other type of loan — is “amortized” if it’s paid in regular installments and will be fully paid off after a set period of time. 

Your mortgage amortization schedule determines when your home will be paid off and how quickly you build home equity. It also comes into play if you want to pay off the loan early. So it’s important to understand how your amortization schedule works. 

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How mortgage amortization works

If the amount you borrow for a mortgage loan is scheduled to be repaid in installments, your loan is amortized.

“Loan amortization is the process of calculating the loan payments that amortize — meaning pay off — the loan amount,” explains Robert Johnson, professor of finance at Heider College of Business, Creighton University.

“On a fully amortizing loan, the loan payments are determined such that, after the last payment is made, there is no loan balance outstanding.”

Amortization also determines what portion of your monthly loan payment goes toward principal or interest.

At the beginning of your amortization schedule, a larger percentage of each monthly payment goes toward loan interest; at the end, you’re paying more toward principal. 

Note: this affects only the breakdown of your payments. If you have a fixed-rate mortgage, the total payment amount will always stay the same.

This background math might not seem like it matters, especially since most mortgages have fixed payments.

But actually, the payment breakdown is very important because it determines how quickly you build home equity — which in turn affects your ability to withdraw equity, refinance, or pay off your home early.

Are all mortgage loans amortized? 

Almost all mortgages are fully amortized — meaning the loan balance reaches $0 at the end of the loan term. 

The exceptions are uncommon loan types, like balloon mortgages (which require a large payment at the end) or interest-only mortgages.

Most lenders don’t offer these — and most home buyers don’t want them — because these loans are riskier and don’t help the borrower build equity as quickly. 

With an amortized loan, your mortgage is guaranteed to be paid off by the end of the term as long as you make all your payments over the full life of the loan. 

How amortization affects your loan payments

Your amortization schedule doesn’t just determine when your mortgage will be paid off. It also determines how each monthly mortgage payment is divided between interest and loan principal. 

“Even though the loan payment every month will likely remain the same total amount, the proportion of interest and principal will differ with each subsequent payment,” explains Johnson.

“In the first payment you make on an amortizing loan — month one — you’ll pay the largest percentage devoted to interest and the smallest percentage devoted to principal.

“Conversely, in the last payment you make — month 360 on a 30-year mortgage loan — the largest percentage of your payment will go toward principal, and the smallest percentage will be devoted to interest,” Johnson notes.

The longer the term of your loan, the longer it takes to pay down your principal amount borrowed, and the more you will pay in total toward interest.

That’s why a shorter-term loan, like a 15-year fixed-rate mortgage, has a lower total interest cost than a 30-year mortgage.

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Amortization schedule example

Here’s an example of how an amortization schedule would look for the following loan:

  • Loan amount: $250,000
  • Loan term: 30 years
  • Fixed interest rate: 3.5%
  • Fixed monthly P&I payment: $1,123

Mortgage amortization table

Each payment is the same total amount ($1,123). But note how more than half the payment goes toward interest in the first year, while only $3 goes to interest at the end of year 30.

Year  Principal Payment Interest Payment Principal Remaining Interest Paid
1 (Payment 1) $393 $729 $249,607 $729
5 (Payment 60) $467 $655 $224,243 $41,599
10 (Payment 120) $556 $566 $193,567 $78,281
15 (Payment 180) $663 $460 $157,035 $109,105
20 (Payment 240) $789 $333 $113,527 $132,953
25 (Payment 300) $940 $183 $61,711 $148,494
30 (Payment 360) $1,121 $3 $0 $154,144

Mortgage amortization chart

As you can see on the chart below, it’s not until year 19 that the amount of principal the homeowner has paid surpasses the amount of interest.

Examples generated using The Mortgage Reports mortgage calculator

Amortization affects only principal and interest

Note that your amortization schedule affects only the principal and interest (P&I) portion of your mortgage payment.

Regular payments include other homeownership costs, too; like homeowners insurance, property taxes, and if necessary, private mortgage insurance and/or homeowners association (HOA) dues.

Payments for these other expenses will not be affected by your amortization schedule. Although, they may be subject to change throughout the loan term — for instance, if your property tax rates or homeowners insurance premiums change.

Why your amortization schedule matters

“Amortization matters because the quicker you can amortize your loan, the faster you will build equity and the more money you can save over the life of your loan,” says real estate investor and flipper Luke Smith.

Look closely at your amortization schedule, and you’ll likely find that your loan will amortize a lot more slowly than you think.

“Many borrowers have a hard time grasping just how little of their monthly payment early on in the life of their loan goes toward repaying principal, and how much of the monthly payment late in the life of their loan is devoted toward repaying principal,” says Johnson.

Homeowners might not pay attention to their amortization schedule, because their total payment does not change.

But if you want to tap home equity or pay off your loan sooner, those principal-versus-interest numbers start to matter.

Building home equity

At the end of a fully-amortizing mortgage loan, you’ll own your home outright. Its value will be 100% equity.

But because of the way mortgage loans amortize, that equity is built up slowly.

For example, you can’t assume that completing half the loan term means you’ll own half the home.

Consider the example above. Although the full loan term is 30 years, it will take the homeowner 19 years — nearly two thirds of the term — to pay off half their loan principal.

If you took out the same loan amount ($250,000) with a 15-year term instead of a 30-year term, you will have paid off half the loan’s principal in year 9.

So a shorter repayment schedule doesn’t just help you save money on interest — it also helps you build tappable home equity more quickly.

Remember, you need more than 20% equity to draw on your home’s value via a cash-out refinance or home equity loan. Your amortization schedule will help you understand when you can reach the magic number to become eligible for home equity financing.

Paying off your mortgage

Some homeowners decide to pay off their mortgage early as a way to save on interest payments.

One way to do this is by refinancing into a shorter loan term, like a 10-, 15-, or 20-year mortgage.

But for homeowners who don’t want the hassle and cost of refinancing, an alternative is to make extra or “accelerated” payments toward the loan principal. Early payments can be in the form of:

  • One extra payment each year
  • Extra money added to each monthly payment
  • A one-time, lump sum payment

Early payments toward your loan’s principal balance can help shorten your amortization schedule. You’ll save money because you won’t have to pay interest on the months or years eliminated from your loan term.

You can use an amortization calculator with extra payments to determine how quickly you might be able to pay off your remaining balance, and how much interest you’d save.

Should you pick a long or short amortization schedule?

Before deciding on a mortgage loan, it’s smart to crunch the numbers and determine if you’re better off with a long or short amortization schedule.

The most common mortgage term is 30 years. But most lenders also offer 15-year home loans, and some even offer 10 or 20 years.

So how do you know if a 10-, 15-, or 20-year amortization schedule is right for you?

Benefits of a short-term loan

The obvious benefit of a shorter amortization schedule is that you’ll save a lot of money on interest.

For example, consider a $250,000 mortgage at a 3.5% interest rate:

  • A 30-year fixed loan would cost you $154,000 in total interest
  • A 15-year loan would cost you only $46,000 in total interest

“Short amortization schedules tend to be a sound financial decision if you are buying a starter home and want to build equity more quickly,” says Nishank Khanna, chief financial officer for Clarify Capital. “It means you’ll be paying more toward the principal upfront.”

Khanna continues, “Borrowers who make a large down payment or plan to make accelerated payments, or those who secure loans with low annual percentage rates can shorten their amortization schedule — thereby paying less money over the life of their loan and accruing home equity much faster.”

However, a shorter amortization schedule isn’t for everyone.

Drawbacks of a short-term loan

The biggest drawback to shortening your loan term is that monthly payments will be much higher.

Using the same example of a $250,000 loan at 3.5% interest:

  • Monthly P&I payments on a 30-year loan are $1,200
  • Monthly P&I payments on a 15-year loan are $1,600

The steep increase means many homeowners simply can’t afford a short-term mortgage.

In addition, choosing a shorter-term loan locks in your higher monthly payments — you’re obligated to pay the full amount each month.

With a longer-term loan, on the other hand, you can pay more to accelerate your amortization schedule if you wish. But you’re not committed to a higher monthly payment.

Check your mortgage options (Jan 16th, 2022)

Can you change your amortization schedule? 

The good news is that even if you opt for a longer repayment schedule — such as a 30-year fixed-rate mortgage — you can shorten your amortization and pay off your debt more quickly by either:

  1. Refinancing to a shorter-term loan; or
  2. Making accelerated mortgage payments

Smith recommends making extra principal payments over choosing a 15-year loan.

“Get the most favorable rate and terms for yourself. Then, if more funds are available in your budget, pay your loan down more quickly than scheduled,” he says.

Smith explains you can “treat your mortgage like a 15-year mortgage rather than a 30-year loan by making accelerated payments, which most mortgage loans and lenders allow you to do without fees or penalties.

“This way, if a financial challenge occurs and you need the funds, you can temporarily or permanently stop making accelerated payments without any problems or repercussions.”

Should you shorten your amortization schedule?

“When interest rates are low and the majority of your payments are going toward principal, there may not be a strong case for paying off a mortgage more quickly,” Khanna suggests.

“If you think you can earn a higher return on your money through other investments like the stock market, avoid a shorter-term amortization schedule.

“Also consider that, when you pay off your mortgage earlier, you will lose out on tax breaks you may qualify for, such as the mortgage interest tax deduction, which can negate savings.”

Mortgage amortization: A personal decision

The decision between a short- or long-term loan should depend on your personal finances.

If you have a lot of monthly cash flow, and you want to save on interest, choosing a 15-year loan or shortening your amortization schedule with extra payments could be a smart strategy.

If you have a tighter budget — or you want to invest your money elsewhere — the traditional 30-year amortizing mortgage makes a lot of sense.

Compare all your loan options before buying a home or refinancing. And make sure you understand how amortization will affect your monthly payments, as well as your home equity options further down the line.

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