Mortgage Basics: The Amortization Schedule

By Lisa Smith

The amortization schedule for a residential mortgage is a table that provides a breakdown of the schedule of payments from the loan's first required payment to the loan's final payment. It details the amount of principal and the amount of interest paid each month. The amortization schedule is one of the most important, yet overlooked, documents involved in the mortgage process, as it shows the true cost of the house. For example:

Loan amount: $100,000
Interest rate: 6%
Mortgage term: 30 years
Number of payments: 360
Monthly payment: $599.55
Total interest paid: $115,838.19

Month	Interest	Principal	Remaining Principal Balance
1	$500	$99.55	$99,900.45
223 (18.5 years)	$298.31	$301.24	$59.361.34
360 (30 years)	$2.98	$596.57	0

In this case, by the time the mortgage is paid off in 30 years, the total interest paid is $115,838.19, bringing the actual cost of that $100,000 house to $215,838.19. The interest on the loan literally adds up to more than the cost of the house itself.

Building Equity
In our example of a $100,000, 30-year mortgage, the complete amortization schedule would consist of 360 payments. As the table shows, each of the required payments is $599.55, but the amount dedicated toward principal and interest varies from payment to payment. The balance between principal and interest payments reverses over time as early payments consist primarily of interest and later payments consist primarily of principal. Because of the inverse relationship between principal and interest paid, the rate at which you gain equity in your home is much slower in the initial years of the mortgage than in later years. This demonstrates the value of making extra principal payments if the mortgage permits prepayment. Each extra payment results in a larger repaid portion of the principal, and reduces the interest due on each future payment, moving you toward the ultimate goal: paying off the mortgage.

Consider what would happen if you make one extra payment of $600 in a year. Typically, the entire value of any extra payments will go toward paying down the mortgage's principal. The partial amortization schedule below demonstrates that making just one extra mortgage payment during the first year of your mortgage will give you nearly as much equity as you would have earned in half a year of making your standard payments. Continue making just one extra payment per year and you can shave years off of your mortgage and eventually save thousands of dollars in interest.

Month	Interest	Principal	Balance
	$500	$99.55	$99,900.45
2	$499.50	$100.05	$99,800.40
3	$499.00	$100.55	$99,699.85
4	$498.50	$101.05	$99,598.80
5	$497.99	$101.56	$99,497.24
6	$497.49	$102.06	$99,395.18

Refinancing
The amortization schedule also plays a role when you refinance a mortgage. The rule of thumb is that an interest rate deduction of 1% or greater may be worth doing and that an interest rate deduction of 2% is almost always worth doing. The truth is, you won't really know if refinancing is worth the money until you look at the new amortization schedule because the amount owed, the interest rate, and the length of time that you plan to own the home all play a role in determining whether refinancing is cost effective. (For more insight, see Mortgages: The ABCs Of Refinancing and The True Economics Of Refinancing A Mortgage.)

Consider our example. If you had been making only the standard mortgage payment on the $100,000 loan for five years and then interest rates fell to 4.5%, you would owe $94,015.39 on the balance of the loan. The monthly interest payment would be $549.10 and the amount going toward principal would be $116.20.

By refinancing to a 30 year loan at a 4.5% interest rate, your monthly payment would decrease to $476.36, with $352.56 going toward interest and $123.80 toward principal. These numbers assume that you pay cash for the closing costs, which could be in the neighborhood of several thousand dollars for this loan. Not only is the new monthly mortgage payment smaller and the amount going toward principal larger, but you will save approximately $8,000 in interest over the lifetime of this loan by refinancing. Just keep in mind that if you sell the house within a few year of refinancing, the cost of refinancing will eliminate the savings in interest.

Negative Amortization
While amortization schedules are typically thought about in terms of paying down a mortgage, they also play a role when the loan agreement allows for scheduled payments that are less than the interest payments over that same time period. To look back at our example, it is possible to get a loan with a monthly payment of $467.36 and a contract that permits you to pay only $367.36. The $100 difference, known as deferred interest, is added to the principal of the loan. Over time, the amount owed on the loan increases, a scenario known as negative amortization.




Negative amortization has become a more common scenario with the increased popularity of certain types of adjustable-rate mortgages, particularly those known as interest-only loans. While these mortgages can provide borrowers with the ability to initially make low monthly payments, the downside is that the monthly payments must increase substantially at some point over the term of the mortgage. Some homeowners find themselves unable to make more than the initial minimum payment and unable to make the higher payment when it adjusts upward. Because the principal of the loan increases over time, refinancing what is now a larger debt than originally financed may be impossible, which can eventually lead to foreclosure. (To learn how to avoid this fate, see Saving Your Home From Foreclosure.)

While the numbers on an amortization sheet can take some of the excitement out of the home buying process, the mortgage payment must still be made long after the thrill of moving into a new home is gone. A careful review of the amortization schedule prior to making a home purchase can help you to determine whether you will be able to meet your financial obligations over the long term.


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