How Amortization Works And What It Means for Your Monthly Mortgage Payment

A photo to accompany a story about amortization Klaus Vedfelt/Getty Images; Illustration by Next Advisor
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With mortgage rates forecast to continue rising, it’s easy to get stuck focusing on your interest rate when you’re trying to reduce your payment. 

But another factor can have an even bigger impact on your monthly mortgage payment — amortization.

Amortization is the time period you repay a loan. For most mortgage loans it will be 30 years or 15 years. It affects how much interest you pay over the life of the loan and how quickly you’ll build equity in your home, says Scott Nguyen, a licensed real estate broker and owner of Oakland, California based mortgage brokerage Made Mortgage. It is also the stabilizing force that can keep the principal and interest portion of your monthly payment fixed for the duration of the repayment period, said Nguyen.

But not all loans are fully amortized, which has its advantages and drawbacks. Given the rising interest rate environment we’ve had this year, it’s important to understand how your loan’s amortization schedule affects your financial future. 

What Is Amortization? 

Amortization on a loan is the process of determining the monthly payments needed to pay off the balance in a certain time frame. For instance, a mortgage loan amortized over 30 years will be paid off in its entirety after making payments for 30 years. On a 30-year fixed interest rate loan, you’ll typically make the same monthly mortgage payment each month for 30 years. 

While each monthly payment could be the same amount, it’s important to understand that with each mortgage payment, different amounts could be going towards the principal and interest, says Mai Huynh, an underwriting manager at online mortgage lender Better.com. “On a brand new loan, the majority of your payments will go toward interest. And the longer the loan term, the more interest you’ll pay over the life of the loan.”  

Pro Tip

If you can afford larger payments, a shorter loan term can save you tens of thousands of dollars over the life of the loan.

An amortization table shows how each payment on a loan is applied toward principal and interest. Understanding how to read an amortization table can be especially helpful for buyers who have to account for private mortgage insurance (PMI), says Nguyen. PMI can typically be removed once a homeowner has 20% equity in their home, he said. With an amortization table, homeowners can see exactly when they can request for PMI to be removed, and plan for the additional monthly savings.   

Which Loans Are Amortized?

There are many different types of loans, and not all of them will be paid off at the end of the loan term. These types of loans are called non-amortizing loans. 

While the monthly payments on a non-amortized loan won’t pay off the full loan balance, they have certain benefits. You could have lower or no monthly payments, but you may have to come up with a lump-sum payment at the end of the loan. 

Here are a few different types of amortizing and non-amortizing loans. 

Amortizing Loans

Conventional fixed-rate mortgage loan: A typical fixed-rate conventional loan will have equal monthly payments over a specified time frame, usually 30, 20, 15, or 10 years. This is considered a secured loan because your house is collateral if you default on the loan. 

Adjustable-rate mortgage loan: An adjustable-rate mortgage (ARM) usually offers lower introductory rates than a fixed-rate mortgage loan, typically 1, 3, 5, 7, or 10 years. While the interest rate change could impact the amount of the monthly mortgage payments, making regular timely payments will still pay off the loan balance at the end of the loan term.

Auto loan: An auto loan is similar to a mortgage loan, but a vehicle is collateral instead of a house. Auto loan payments are typically equal monthly amounts paid over 3 to 7 years. 

Personal loan: Borrowers can use personal loans for just about any reason. These loans typically have higher interest rates since they are unsecured loans. 

Home equity line of credit (HELOC): A home equity line of credit (HELOC) is like having a credit card backed by the equity in your home. A lender provides you access to a line of credit based on the equity you have in your home and you can draw on that line of credit for a certain period of time.

Non-Amortizing Loans

Interest-only loan: With an interest-only loan, borrowers can benefit from lower monthly payments as the payments will only cover the interest portion of the loan during an interest-only period.  

Balloon mortgage loan: Balloon loans have either no monthly payment or lower monthly payments compared to conventional mortgages. At the end of a set period of time, however, a borrower must pay off the loan with a lump-sum payment. 

Deferred interest loan: Deferred interest loans allow the borrower to avoid paying the interest for a specified period of time. Usually, if the loan is paid off before the end of this time frame, the borrower will not owe any interest. However, if the loan is not paid off, interest will start to accrue. 

Amortization vs. Depreciation

Amortization and depreciation are similar concepts, but there are differences. With an amortization schedule, payments are designed to reduce the loan balance to zero after a certain time frame. With depreciation, the value of the asset is reduced over a specified time period. 

Put simply, assets depreciate as their useful life is reduced. For instance, cars that have been driven for several years depreciate in part because they are not expected to last as long as a brand new one.  

Homes can also depreciate with normal wear and tear But increases in home values can outpace depreciation. Homeowners can keep their property’s value high by being proactive with preventative maintenance, repairs, and renovations. 

Examples of Depreciating Assets

  • Homes
  • Cars
  • Computers
  • Airplanes
  • Cell phones

How to Read an Amortization Schedule 

Let’s walk through an example of how to read an amortization schedule for a mortgage loan. 

Using this amortization mortgage calculator, enter a purchase price of $350,000, a 10% down payment, and a 30-year loan at a 4.7% interest rate on the left-hand side.  

  • On the “payment breakdown” tab, you can see the monthly principal and interest payment is $1,633. 
  • The “payment breakdown” section also allows you to enter your monthly homeowner’s insurance, property tax, and HOA fees.
  • On the “amortization schedule” tab you can see how each payment is broken down into the principal and interest portions. For instance, the first monthly payment of $1,633 has $399.25 applied towards the principal balance, while $1233.75 is applied toward interest. 
  • With each subsequent monthly payment of $1,633, a larger portion is applied to the loan principal.

On the left-hand side of the amortization schedule is the date of each payment. This gives you the ability to see the exact loan balance on each date and makes it easy to see when you’ll be able to get rid of PMI.