Amortization Schedule
Owning a real estate, a home or an expensive factory is never an easy investment. With the aid of a mortgage loan, many people have been empowered and are now proud owners of expensive real estate and family homes.
Such mortgage loans are not an easy debt, there are always as big as your house. Thus, the best most of us can hope to do is to shorten the term by prepaying as much of the mortgage loan that we can as quickly as we’re able.
What is an 'Amortization Schedule Mortgage?'
An amortization schedule mortgage is an accounting record or a complete table or chart of periodic mortgage loan payments, showing the loan payment number, payment date, amount of principal, the amount of interest that comprise each payment and the balance owing after that payment has been made until the loan is paid off at the end of its term. Early in the schedule, each periodic loan payment is the same amount with the majority of each payment being the interest. Later on in the schedule, the majority of each loan payment covers the loan's principal. The last line of the schedule represents the borrower’s total principal and interest payments for the entire loan term.
In such an amortization table, the percentage of each payment that goes toward interest reduces with each payment but the percentage that goes toward principal increases. For instance, the first few entries of an amortization table or schedule for a $200,000 with a 12% interest rate over 30-year fixed-rate mortgage amortization starting June, 2017 looks thus (using an amortization formula):
Date |
Interest |
Principal |
Balance |
Jun, 2017 |
$2,000 |
$57 |
$199,943 |
Jul, 2017 |
$1,999 |
$58 |
$199,885 |
Aug, 2017 |
$1,999 |
$58 |
$199,827 |
Sep, 2017 |
$1,998 |
$59 |
$199,768 |
Oct, 2017 |
$1,998 |
$60 |
$199,708 |
Nov, 2017 |
$1,997 |
$60 |
$199,648 |
Dec, 2017 |
$1,996 |
$61 |
$199,587 |
2017 |
$13,988 |
$413 |
$199,587 |
How is an Amortization Schedule Mortgage Calculated?
There are many freely available online calculators that create amortization tables or schedules automatically. While this is good, the downside to this is that people are less informed on the mathematical calculations involved in creating the schedule. We have taken out time to provide the step-by-step calculations for a simple fixed-rate mortgage amortization.
Assuming you purchased a new home using a mortgage loan of $380,000 and a down payment of $80,000. The bank thus provides you with a $300,000 for a period 30 years mortgage amortization at a fixed interest rate of 5%. How much money will you be paying towards interest and principal each month? What is your monthly payment? Let's go through the calculation process.
Step 1: Calculate the total number of payments
We are expected to make a payment per month for 30 years. This simply means you will make 12 x 30 = 360 payments over the course of the mortgage lifespan.
Step 2: Calculate the monthly interest rate
Since the 5% is an annual interest rate, and we are basing our calculation on a monthly payment schedule, the annual rate should be converted to a monthly rate thus;
5% / 12 = 0.4167%
The monthly interest rate is 0.4167%
Step 3: Calculate the monthly payment
To determine the monthly payment amount to account for interest requires the compilation using the amortization formula shown below.
A = [i * P * (1 + i)^{n} ] / [ (1 + i)^{n} – 1]
P = loan's initial amount
i = monthly interest rate
n = the total number of payments.
A = the monthly payment
By using our statistics (P = 300,000, i = 0.4167% (i.e. 0.004167), n = 360), and the amortization formula yields a monthly payment of $1,610.5.
Step 4: Calculate the total interest
At this point, we are now able to determine the total cost of the loan.
Making a 360 payments of $1,610.5
The total cost = 360 * 1,610.5 = $579,780
Subtracting away the original loan amount ($300,000) gives
Interest = 579,780 – 300,000 = $279,780
Thus, even though the interest rate is only 5%, you almost pay as much in interest as the original mortgage loan
Step 5: Calculate the breakdown of each monthly payment
Although the monthly loan payment is fixed, the total amount of money paid to interest and principal varies each month. The amount remaining after the interest has been deducted is used to pay off the loan itself. The amortization formula above ensures that after 360 payments period, the mortgage loan balance will be $0.
For the first payment, we have already calculated and the total amount is $1,610.5. In order to calculate how much of that goes toward interest, we multiply the remaining balance ($300,000) by the monthly interest rate: 300,000 x 0.4167% = $1,250.1. The rest goes toward the mortgage amortization balance ($1,610.5 - $1,250.1 = $360.4). So after the first payment, the remaining mortgage loan amortization will be $300,000 - $360.4 = $299,639.4.
The second and subsequent payment's breakdown is similar except the mortgage amortization balance is decreased by the interest. So the portion of the payment going toward interest is now slightly less: $299,639.4 * 0.4167% = $1,248.6.
This process of calculating interest based on the remaining balance continues until the mortgage loan is completely paid off. Thus, after each month payment, the amount of interest declines and the amount going to paying off the loan amortization increase. After 360 payments, the mortgage loan amortization is fully paid off.
Bear in mind that our calculations here do not take into consideration any additional costs such as property taxes, mortgage insurance, or closing costs.
Fully Amortizing Payment
Fully amortizing payment refers to a periodic mortgage loan payment, where the borrower makes payments according to the loan's amortization schedule, thus the loan is fully paid-off by the end of its lifespan. If the mortgage loan amortization is based on an adjustable-rate, the loan amortizing payment amount changes as the interest rate on the mortgage loan changes. But if on the other hand, the loan is based on a fixed-rate, each fully amortizing payment is an equal dollar amount.
To understand the fully amortization payment concept better, let’s consider a scenario where borrower takes out a 30-year fixed-rate mortgage with a 4.5% interest rate, and his monthly payments are $1,610.5. At the beginning of the loan's payment life, the majority of the payments are allocated to interest and just a small percentage to the loan's principal, but near the end of the loan's lifespan, the majority of each payment goes to cover the principal and only a small portion is devoted to interest. Because these payments are fully amortizing, if the borrower makes full payment each month, he eventually pays off the loan by the end of its lifespan.
Negative Amortization
Negative amortization is the direct result of an increase in the principal balance of a mortgage loan caused by making monthly payments that fail to cover the interest due. The principal is increased due to the addition of the remaining amount of interest owed to the loan's principal.
For instance, consider a loan situation where the periodic interest payment on a loan is $1000. If an $800 payment is made, $200 (the interest balance) is added to the principal balance of the mortgage loan.
Fixed-rate mortgages with negative amortization feature are known as graduated payment mortgages while adjustable-rate mortgages with a negative amortization feature are generally known as payment option ARMs.
While these mortgage usually provides borrowers with the capability to make low monthly payments over a long period, the monthly payments usually increase substantially at some point over the lifespan of the mortgage. For a fixed-rate graduated-payment mortgage, the date or dates when payments increase on the loan are known with certainty. Whereas, with the payment option ARMs, also have some scheduled payment increases, but instead they carry triggers that can cause the mortgage to recast before a scheduled payment increase. Thus, payment option ARMs carry a great deal of risk or payment shock.
Negative amortization cannot continue indefinitely. At some point, the loan starts to amortize over its remaining term. Generally, negatively amortizing loans have a negative amortization limit which states that when the principal balance of the loan reaches a certain contractual limit, the payments will be recalculated or have scheduled dates when the payments are recalculated. This is to allow the loan to amortize over its remaining term.
Accelerated Amortization
This type of amortization involves additional payments made towards paying down a mortgage principal. Here, the mortgage loan borrower is allowed to add extra payments to their mortgage bill in order to pay off a mortgage before the loan settlement lifespan. The benefit of this amortization type is a reduction in the overall interest payments.
For instance, assume a mortgage loan originated for $200,000 for 30 years at 7% interest rate. The monthly interest and principal payments is $1330.60. Increasing the monthly payment by $100 ($1430.60) per month will result in a loan payoff lifespan of 24 years instead of the original 30 years, hence, saving the borrower six years of interest. Paying a mortgage loan in an accelerated amortization manner decreases the loan premium faster and diminishes the amount of additional interest the borrower is required to pay on the loan.
The Advantages and Disadvantages of Amortization
The benefit of amortization is that it offers a guaranteed way to pay off your mortgage.
As you pay down your loan, even if you make no extra payments, due to amortization, you’ll over time own your home free and clear by the end of the loan payment period. In addition, with each payment you make, your equity grows just a little bit. Other benefits include:
Useful Life
Amortization is considered part of generally accepted accounting principles, and the Internal Revenue Service (IRS) has rules on how businesses must amortize and depreciate costs for business tax deductions. This process helps borrowers to benefit from tax reduction. For most assets, the IRS publishes tables of the useful lives of the most commonly tax deduction assets.
Accrual Accounting
Amortization is concepts used in accrual accounting, which allows business owners record income and expenses more closely to the time they actually occur. Any major asset a business purchases like buildings or equipment, it will be used over a period of many years to help generate sales, and revenue. Over time, these assets values depreciate and may require replacement. Accrual accounting provides entrepreneurs with a better picture of the long-term profitability.
Straight-Line Depreciation
There are generally two types of depreciation. The straight-line depreciation allows you to consistently reduce the asset’s value over its useful life. This makes it the simplest and most commonly used way to calculate depreciation. Using straight-line depreciation, if you purchased a $10,000 machine with a useful life of 10 years, you would consistently deduct $1,000 yearly for the machine as a business expense.
Accelerated Depreciation
Another benefit is accelerated depreciation. In this case, the business owners take a larger deduction up front in the early years after the loan purchase which quickly reduce the amount taken in the later years of the asset’s useful life. With such up front deductions, the business gets the tax break early but will also have fewer deductions later.
Amortization
Amortization applies to intangible assets, which can include brand names, copyrights, software, licensing agreements, patents, research and development costs, and non-compete agreements including labor, financial and other costs, used to build, buy or acquire an asset may be amortized as a capitalized cost. Amortization like depreciation, allow businesses spread their costs for assets over time to get a more consistent accounting of expenses and income.
The downside of amortization comes with its very slow rate.
As you pay down the mortgage loan, the principal only go down slower and it’s disappointing to most borrowers who wish to get the total loan pay off in the shortest possible time.
Due the fact that most of the interest is paid in the first years, and most of the principal is paid in the later years (interest is front-loaded on a mortgage), it will be generally many years into your mortgage payment before you’ll start seeing any meaningful reduction in your loan balance.
By making prepayments (extra payments) you can accelerate the amortization process, enabling you to pay your mortgage off early.
Payment Rigidity
This is the mayor problem or downside with the existing mortgage is the absolute rigidity of the payment requirement. When you skip a payment, you accumulate late charges until you make it up. For example, if you skip June 2017, you are required to make it up with 2 payments in July 2017 together with one late charge. You will also record a 30-day delinquency report in your credit file. If eventually, you can’t make it up until July 2017, the price is 3 payments in August 2017 and 2 late charges plus a 60-day delinquency report in your credit file, and so on... Falling behind can be a slippery slope into foreclosure.
Payment rigidity also prevents many borrowers from organizing their personal finances in the best way.
How Amortization May Work Against
From our examples above, we can conclude that, amortization work best slowly over a long period of time.
Because of this, borrowers may at one point along the loan payment life consider refinancing. Before engaging into this, borrowers have to consider the impact refinance will have on their effort to one day own your home mortgage-free.
The primary reasons people consider refinancing their mortgage is to lower their monthly payment.
Getting a lower monthly payment can be achieved in two ways. Lower the interest rate or to lengthen the term of your new loan.
For example, assuming you collected a 30 years loan and 10 years into the loan payment, you refinance back to another 30 year loan, your new monthly payment will be lower. You’ll also have to start the amortization process all over again.
The best way to refinance your loan, if you want to keep yourself on the original payoff schedule is to set the term of the new loan to no more than the number of years you have remaining on the old loan or 20 years in our example.
If for example you’re 15 years into a 30 year loan, a refinance should be limited to 15 years, the same number of years you have to go on your current mortgage.
The recasting of loan terms back to 30 years was one of the biggest reasons why so many people watched their equity evaporate during the housing meltdown.
If you keep recasting your mortgage back to 30 years, your amortization schedule mortgage will remain stuck in slow motion robbing you of the best chance to completely payoff your mortgage.
Conclusion
Amortization is a new concept, which you don’t have to shy away from it. The loan amortization generally implies that your loan payment is set up in a way that its takes a specific amount of time to completely repay it. As you proceed with the payment, a percentage of your payment goes to the principle and some to the interest. How much goes to each will change over time.
At the beginning of the mortgage amortization, the bulk of the amount you pay goes to the interest while at the end, you pay more principle. Also, realize that the quicker you can start paying more toward your principle, the quicker you build up your equity and you pay off your loan faster too.