Getting your first home loan is an exciting time which requires a lot of planning and preparation. Sometimes when dealing with a field you're not used to, half of the battle is getting your head around the different terms people use to describe documents and procedures, and with mortgages, the amortization schedule is a prime example of such a term.
One of the most important tools in managing your mortgage, the amortization schedule is something all mortgage owners should have a working knowledge of in order to keep on top of their finances. Here we'll explain what an amortization schedule is and the different ways in which it can be used.
What Is An Amortization Schedule?
Simply put, amortization is the process of paying off a debt, in this case your mortgage, over a period of time through regular payments. These payments go towards two main costs for your mortgage: the principal balance and the interest. How much of your monthly payments go towards the principal and the interest is determined by the amortization table, and this is an excellent tool to work out how much your house actually costs, once all your principal and interest has been repaid.
Increasing Your Equity
Another use of your amortization schedule is seeing how much equity you have on your property. Typically this will be a very small amount initially because your payments go towards the interest costs of the loan and not the principal balance, this ratio gradually reversing over time. One way to save a lot of money on interest in the future is to make an extra payment towards your principal balance in the first year (if your mortgage will allow it).
For example: Say your loan is $100,000 with a mortgage rate of 6% over 30 years. Your monthly payment is $599.55. Using an amortization schedule you can deduce that paying a one off, extra $600 towards your principal balance in the first year can almost double your equity initially:
Repeatedly making this extra payment during the first few years of your mortgage can help to greatly reduce the amount of interest you have to pay each month, ultimately reducing the time it takes to pay off your loan and saving you money.
Re-amortization Or Refinancing
The amortization schedule is also an essential tool when deciding whether to refinance a mortgage.
Initially an appealing option, those in a tight financial spot may believe that refinancing their mortgage could be the perfect solution: lower monthly payments with a seemingly larger amount of them dedicated towards paying off the principal balance.
In reality this isn't the case, and re-amortizing begins the whole mortgage process again simply with the cost of the property increasing and the principal/interest ratio the same, something which an amortization schedule can reveal.
There are of course different amortization methods, the above declining balance example just one of them. Another amortization schedule is one of increasing balance, also known as negative amortization. In this scenario, the borrower is permitted to pay back an amount which does not cover the interest on their principal loan, the remainder of which is added to their principal balance.
Example: the interest payment on a loan is $600 and $450 of this can be paid contractually in a specified period. The remaining $150 is then added to the principal balance the borrower is paying off.
Mortgages which have this feature include fixed rate graduated payment mortgages and payment option adjustable rate mortgages, or ARMs.
These types of mortgages don't suit everyone and can be risky with their sudden payment increase, so using an amortization table to re-evaluate costs after the initial interest has been paid is important.
As you may have deducted, keeping track of your amortization schedule is crucial in making the right decisions when it comes to managing your mortgage. Not only does it break down your monthly payments to reveal interest and principal portions but also illuminates how much principal and interest you have paid at any given point, revealing the remainder of each and reminding you of how far there is left to go.
One way of ensuring that your interest rates don't hinder the repayment of your principal balance is to make sure you have the best mortgage rates to begin with.
Despite this being a substantial task with a lot of research, there are many great mortgages out there which will suit your situation.
Use GET.com's Mortgage Genius tool to get real-time best mortgage rates from major lenders in your state today. Once you input your information, you'll be shown the best rates for your property in seconds!