If you’re looking into getting a mortgage for the first time, congratulations! You’re about to embark on a brave new adventure in adulthood. Like most adventures, it comes with some highs and some lows.
One of the highs might be when you finally find the perfect home in your price range. As for the lows, one of them could well be trying to understand all the jargon that’s involved in buying a house.
Home-buying terminology can be somewhat intimidating. What’s the difference between prequalification and preapproval? Why are there so many different types of mortgage loans? What in the world is escrow? And what does amortized mean?
Related: Tips when shopping for a mortgage
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What is Amortization?
We’re going to answer that last question, quickly and painlessly. Basically, mortgage amortization just means that your mortgage loan payments will be spaced out over a set period of time (often 30 years) and will be calculated so that you always pay the same amount per month (if you have a fixed rate mortgage, not a variable rate mortgage).
That means that if you get a fixed rate mortgage and your first payment in your first month is $1,500, you know that you’ll pay $1,500 in the last month of your mortgage, years later. If you take out a variable rate mortgage, the amount you pay each month will change periodically as the market rate fluctuates.
Just because you’re paying the same amount for your fixed rate mortgage each month doesn’t mean that your payment is going toward the same things each month. In fact, your first mortgage payment will go primarily toward interest, and your last mortgage payment will go primarily toward the principal.
Throughout the life of your loan, this balance paying off interest to paying off principal will gradually shift as more of your principal is paid off (and therefore generates less interest).
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Why do People Choose Amortized Mortgages?
Mortgage amortization helps ensure that your obligations are predictable, which can make it easier for you to plan. If you take out a 30-year mortgage, then the amortization helps guarantee that in 30 years, you will have finished paying it off.
For a fixed rate mortgage, amortization also keeps all your payments consistently the same amount, rather than different amounts that depend on how much your principal is.
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How to Calculate Amortization Using Tables
In real life, even if you choose an amortized mortgage, you may never need to figure out your 30 years or so of payments yourself. But it’s useful to see what goes into the table or payments (they’re not arbitrary!) and understand how it’s populated. Calculating your amortized mortgage really puts you on the front lines of homebuying.
Let’s say you take out a $100,000 mortgage over 10 years at a 5% fixed interest rate. That means your monthly payment will be $1,061. You can then divide your interest rate by 12 equal monthly payments. That works out to 0.4166% of interest per month. And that, in turn, means that in the first month of your loan, you’ll pay around $417 toward interest and the remaining $644 toward your principal.
Next, to calculate the second month, you’ll need to deduct your monthly payment from the starting balance to get the ‘balance after payment’ for the chart. You’ll also need to put the $417 you paid in interest and $644 you paid toward the principal in the chart. Then you can repeat the calculation of your monthly interest and principal breakdown, and continue inputting until you finish completing the chart.
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How to Calculate Amortization Using a Calculator
So you can see that it’s not so much difficult to calculate your amortized payments as it is time-consuming. Fortunately, you can save yourself the trouble by using an online amortization calculator.
All you have to do is input info about your mortgage, including the amount you’re borrowing, your term length, and the interest you’re paying, and the calculator will do the math for you.
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What Are the Pros of an Amortized Mortgage?
1. You’ll slowly but surely pay off the principal of your home loan
With every month, you’ll get closer to owning your home outright!
2. It ensures that you pay a set amount for each payment over the life of your loan
With some loans you may end up paying more at the beginning or the end. A balloon mortgage, for example, requires you to pay interest charges monthly during the regular term. You then pay off large parts of the principal at the end of the loan period. (Thus, your payment literally balloons.)
3. You can often get better terms with an amortized loan
And you’ll save money in the long run by paying less interest over the life of your mortgage.
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What Are the Cons of an Amortized Mortgage?
1. Larger down payments
Amortized mortgages favor borrowers who are putting down a larger down payment. To qualify for a competitive interest rate, you’ll probably need to put down 10% (if not 20%).
2. It’s harder to qualify
You might not be able to qualify to borrow as much money via an amortized mortgage as you would through an alternative mortgage, such as an interest-only mortgage or a balloon mortgage.
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