Amortization is the method used to allow people to make large purchases such as a house or a car and pay them off over an extended period of time. When the initial purchase is made a lender gives you the money to purchase the property and you then pay them back through an amortization mortgage. Understanding the way amortization works is key to paying the minimum in interest over the life of your loan.
If you borrowed $100,000 to purchase a home with a 3.5% interest rate for a term of 30 years you would pay $61,657.36 in interest on that loan if you made every monthly payment and no additional payments.
Here is a snapshot of the first year of payments against this loan:
Notice that as the balance on the loan goes down, so does the interest paid each month.
A portion of each payment is divided between a principal payment and an interest payment. The important thing that many people do not understand about amortization is that the interest payment is calculated monthly. The lender takes your interest rate and divides it into a monthly interest percentage. Every month your lender looks at the loan balance and calculates the monthly interest that is owed. Your total payment stays at an exact number every month but how that money is divided changes monthly. This means that when they calculate the interest owed that month, whatever is left after the interest payment and escrow costs are deducted, the remaining funds go against the principal.
The best way to reduce your interest charge and increase what you pay on principal each month is to reduce your loan amount.
If you wanted to pay off that $100,000 loan faster, you could opt to put a little additional down on the principal each month. If you paid $50 extra every month for the life of the loan you would end up paying the loan off nearly 5 years faster thus shortening the loan term to 25 years and you would save a whopping $11,000 on that total anticipated interest amount of $61,657.36.
If paying extra every month doesn’t work for you consider taking your annual tax return or annual bonus and applying that towards the principal of your mortgage amortization. Making the effort to bring this balance down will save you thousands and reduce the number of years you have to pay on this debt.
If you are in the process of applying for a mortgage with Title Mortgage, make sure you ask us for an amortization schedule of your loan. This information can help you plan payments and it can save you money.