On the surface, loan amortization is easy to understand. But the concept can also be incredibly nuanced depending on the details of your mortgage and what you are trying to accomplish. You will find a loan amortization schedule on your mortgage statement, and it will detail exactly where your payments are going each month.
While it may appear set in stone, you can alter your amortization schedule at any time using simple techniques. Whether you want to lessen the amount of interest paid or reduce the term, below, we’ll go over four tips that can help you flexibly take control of your mortgage, no matter what your objective is.
What Is Loan Amortization?
Loan amortization is a way to describe a mortgage with regularly scheduled monthly payments that are applied to the principal and interest owed in that period. The interest is always paid first, and the remaining amount is then applied to the principal. As the interest owed each month is calculated with a
declining principal, your interest payments decrease as the loan balance is paid down.
The first key takeaway to note is that the more you pay down your principal, the lower your interest payments will be each month. On a 30-year fixed-rate mortgage, the bulk of your interest will be paid during the early years of the loan. However, a few tips and tricks are available to homeowners, which
allow you to pay off your loan faster, leading to less total interest paid.
Tip #1: Chose a 15-year mortgage if you can afford it
A 30-year fixed rate mortgage is more popular amongst homeowners. But not because they’re cheaper in the long run. One of the benefits of a 30-year mortgage is lower monthly payments, an advantage valued by many. However, while your monthly payment goes down the longer your repayment period is, the amount of interest you pay is significantly higher over the course of the loan.
Tip #2: Utilize accelerated amortization
Let’s say your original mortgage was on a 30-year fixed-rate schedule, but you’ve realized paying down your debt and reducing the interest owed each month is in your best interest. Accelerated amortization involves an additional monthly payment to reduce the principal even further, thus lowering the amount of interest you will pay that month, and over the course of the loan.
There are three main benefits of accelerating your amortization or opting for a 15-year mortgage rather
than a 30-year:
– You pay down your debt quicker
– The equity in your home increases at a faster rate
– The amount of interest you will pay over the life of the loan is significantly lower
The number of years you can take off your mortgage will be unique for every borrower, depending on the terms of your loan. For many, an extra $100 payment can reduce the length of a mortgage from 30 years down to 25 years. An extra $300 payment per month could potentially take 10 to 12 years off the back end of a mortgage.
Another way to accelerate your amortization is to make one additional lump-sum payment per year. A popular option for quickly finding the funds to make a lump sum is to designate your tax refund each year to pay down your principal.
Tip #3: Attack your principal early in the loan
In the early years, it might feel frustrating that a large percentage of your mortgage payment is going towards interest. While it should be comforting to know that with each monthly payment you are paying less and less interest as the principal amount slowly shrinks, you can accelerate the process by attacking your principal early.
Some might understandably be overwhelmed at the monthly payment on a 15-year mortgage. Others might balk at making an additional payment each month or designating their tax refund each year to pay down the principal. But even if these are not sustainable long-term solutions for you, consider chipping away at your principal in the early going to skip over some of your largest interest payments.
Tip #4: Choose a house you can afford
This tip might seem obvious and unnecessary. However, the definition of affordability is not a black and white issue. You might be approved for a loan that is larger than you need. Or potentially you are approved for a loan based on the salary from a job that you will no longer have in five years. Only you know how much is too much when it comes to the size of your home and the accompanying size of your mortgage. By taking out a smaller loan, you will have much more flexibility when it comes to making an additional payment or choosing a 15-year over a 30-year term.
Bottom Line on Loan Amortization
The beauty of most mortgages is that as a borrower, you always have the flexibility to make your loan work for you. The easiest way to pay off your mortgage in the least amount of time for the lowest amount of interest is typically by securing a 15-year fixed-rate loan from the start. Many borrowers,
though, cannot afford the large monthly payments that come with a shorter-term loan.
Fortunately, no matter what your current loan looks like, you can always talk to your mortgage broker about ways to lower your interest or pay off your debts faster. The key to making loan amortization work for you is to first understand how it functions and where your payments are distributed. Once understood, you can plan out the perfect strategy that fits your comfort level and allows you to fully optimize your homeownership.