When you obtain a traditional mortgage from any type of institutional lender (banks, savings & loans, credit unions, mortgage bankers, etc.), repayment terms typically call for monthly installments, consisting of principal and interest, paid over a fixed number of years/months. What we just described is Amortization. In today’s Post we want to take a look at Amortization Schedules (also known as Amortization Tables) whose function is to break down the principal and interest component of each payment. We want to identify the normal amortization pattern, and address the most common question that arises when discussing the amortization of long term debt: How can I accelerate repayment of this loan?
For the purposes of today’s Post we are only dealing with traditional mortgage amortization. (Not interest-only, not simple interest, not bi-weekly payments, nor any of the other exotics). Taxes, Hazard Insurance, Mortgage Insurance, HOA Dues and Mello Roos are not included in our discussion.
To better understand traditional mortgage amortization schedules, please keep three things in mind:
- Each traditional mortgage payment includes a portion of the principal owed, and the accrued interest.
- Interest accrues on the unpaid principal balance.
- Interest is paid in arrears. This means that the mortgage payment you make in February include your principal payment for the month of February, and the interest accrued during the month of January.
For example, assume you have a new mortgage in the amount of $300,000, with a 3.5% fixed rate, amortized for 30 years (repaid over a period of 360 months). Your first month’s Principal and Interest payment (let’s call it January), would be $1,347.13, consisting of $472.13 in principal and $875.00 in interest.
To calculate the February payment we would subtract the $472.13 we paid toward principal last month from our beginning balance of $300,000.00. Our new balance is now $299,527.87. Since interest accrues on the unpaid principal balance we have to calculate the annual interest @ 3.5% and prorate monthly. ($299,527.87 x 3.5% = $10,483.48 / 12 = $873.62). As such, February’s payment would consist of $473.51 in principal and $873.62 in interest. Notice that February’s principal allocation of $473.51 is a little higher than January, and the $873.62 interest allocation is a bit lower. This pattern continues for the next ten years and four months, until finally, on payment 124 the amount paid toward principal ($675.52), exceeds the amount paid toward interest, ($671.61). Of course the total payment of $1,347.13 remains the same.
If you keep the loan until its final payment you will pay $184,969.51 in interest over the loan’s life. When you consider the amount of interest that will accrue, and that is accrues on the unpaid principal balance, an engaged borrower will ask the obvious question: What can I do to accelerate reduction of my principal? What comes next is a serious case of the What-Ifs, as in What-If I had a 20 year loan instead of 30? What-If I made one extra payment each year? What-If I made two? What-If we paid an extra $100.00 per month? All are relevant questions, so within the context of our example above, we’ve provided answers to the most frequently asked What-Ifs in the following table (TABLE 1):
| TABLE 1: $300,000 Loan 30 Yr. Fixed | 3.5% |
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| What If | Payment | Extra | Interest Paid | ||
| Payment | Life of Loan | Months To Repay | Years To Repay | ||
| 30 Year Term | 1,347.13 | 184,968.26 | 360 | 30 | |
| 25 Year Term | 1,501.87 | 150,561.21 | 300 | 25 | |
| 20 Year Term | 1,739.88 | 117,571.00 | 240 | 20 | |
| 15 Year Term | 2,144.65 | 86,036.57 | 180 | 15 | |
| 10 Year Term | 2,966.58 | 55,989.12 | 120 | 10 | |
| 1 Extra Payment Yr | 1,347.13 | 171,449.38 | 316 | 26.3 | |
| 2 Extra Payments Yr | 2,694.26 | 152,517.71 | 282 | 23.5 | |
| 3 Extra Payments Yr | 4,041.39 | 137,843.67 | 254 | 21.1 | |
| $100 Extra per month | 1,447.13 | 173,022.30 | 319 | 26.6 | |
| $200 Extra per month | 1,547.13 | 154,808.91 | 287 | 23.9 | |
| $300 Extra per month | 1,647.13 | 140,413.90 | 261 | 21.8 | |
| $400 Extra per month | 1,747.13 | 128,727.82 | 239 | 19.9 | |
| $500 Extra per month | 1,847.13 | 119,038.25 | 221 | 18.4 |
Here’s an amortization calculator to run your own scenario (tips on using the calculator appear at the end of the Post):
- If you just want the Principal & Interest payment, enter 0 in the Property Tax, PMI & Property Insurance fields.
- Principal & Interest includes the unpaid principal balance and the interest that accrued in the previous month.
- Interest is paid in ARREARS, so April’s mortgage payment includes the principal payment for April and the interest that accrued during the 31 days in March.
- The calculator asks for all annual assessments to provide you with an all inclusive monthly payment. The goal is to make sure you understand the recurring financial expenditures required to own the home.
- The annual property insurance should include all insurance the lender requires, plus additional insurance you choose to purchase. This includes fire, flood and earthquake coverage. Add the annual premium for each type of coverage and place the total in that field.
- VA loans require NO Monthly PMI (Private Mortgage Insurance) and NO Down Payment, so those fields are defaulted to $0.
- In California, property tax rates can be found on the county tax assessor websites for each county. To calculate the annual taxes multiply the purchase price times the tax rate. For example, in San Diego County the tax rate is 1.25%, so if you’re buying a $500,000 home the annual property taxes would be $6,250 ($500,000 x .0125).
- The calculator will give you the total monthly payment including Principal, Interest, Property Taxes, Hazard Insurance, and PMI or Private Mortgage Insurance (PMI is $0 on VA loans).
- The Monthly Amortization Tab gives you a principal & interest breakdown for every month in the Amortization Period (30 years = 360 months). There is also an annual Amortization Schedule that breaks down the principal and interest paid each year in the Amortization Period.