Mortgage Amortization

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What On Earth Is Mortgage Amortization?

In 2003 we purchased over 8 million new or used homes in the United States with over $3,7 trillion in mortgages being taken out to finance either new purchases or refinance existing mortages. The number of houses we purchase as a nation increases year upon year but do we really understand our financial obligations and how mortgage amortization works?

Well we all know what a mortgage is it's a loan given by a mortgage lender to enable us to finance the purchase of a home. This money is lent to us at a mortgage interest rate set by the mortgage lender. We make monthly payments to pay the interest on the loan and the original sum of money lent to us, known as the principal.

Simple!

But what on earth is Mortgage Amortization?

Your monthly or bi-weekly mortgage payment is made up of two parts:

  • an interest payment which is the interest due that month on the loan
  • a principal payment paying back part of the original loan.

The principle payment reduces the original loan balance month upon month and this is known as mortgage amortization. The aim of your repayments is to have paid back the entire principal by the end of the mortgage term.

Of course the explanation noted above assumes that your interest rate on your mortgage never changes. This would be the case if you choose a Fixed Rate Mortgage (FRM). However if you decide to opt for a Adjustable Rate mortgage (ARM) or a mortgage that has low initial rates whereby your monthly payments only pay off the interest for a certain period, this can change the makeup of your mortgage amortization completely.

Ask for a mortgage amortization schedule

When you have chosen which lender and which product you are going to use to finance your purchase, be sure to ask them for a mortgage amortization schedule. This is a big term for a simple calculation sheet that shows you month upon month, if you pay the same amount, your contribution to the principal payment over the years increase as the interest payment decreases.

Check for negative amortization

You should always ask your mortgage lender or mortgage broker to fully explain the implications that the type of mortgage you take has on your mortgage amortization. You could end up in a situation where you have negative amortization the monthly repayment is not covering the interest on the loan let alone a capital repayment. This is not necessarily a bad thing but imagine the shock you would have if you didn't know and after a year the actual amount you owe the mortgage lender has gone up instead of down! You really need to make sure you fully understand the mortgage product you are purchasing and persistence is the key.