Amortization
This article focuses on the amortization schedule and discusses what amortization is and how an mortgage amortization schedules, helping borrowers to understand money apportioning for a monthly mortgage. The article also enables a borrower to understand how to calculate monthly payments on fixed-rate and adjustable-rate mortgage. Readers should note that the formula for a fixed-rate mortgage is simpler than the adjustable-rate mortgage, and careful attention should be given to the ARM formula. An amortization table is provided so readers can better understand the formula used to calculate amortization.
With an improved knowledge of amortization, potential borrowers should better understand the following:
- How mortgage payments work. For example, how much of the monthly payment is applied to interest vs. principal.
- How fast the borrower can pay down principal
- How monthly payments are calculated (and recalculated) on an adjustable-rate mortgage
One of the most important financial obligations that most people have is their monthly mortgage payment. Borrowers hear it all the time - people worry about paying the mortgage, work to pay the mortgage, wonder how much they will have to pay in order to pay down/pay off the mortgage, etc.
The following article will help borrowers to understand:
- How a mortgage payment works. For example, how much of the monthly payment applies to interest vs. principal?
- How fast a borrower can pay down the principal?
- How to calculate monthly payments (and recalculate) on an adjustable-rate mortgage?
This article focuses on amortization and discusses what amortization is and how it works. This article covers apportioning of a monthly mortgage payment. It also helps to provide an understanding about how to calculate monthly payments on fixed-rate and adjustable-rate mortgages.
What is an Amortization Schedule?
An amortization schedule is the payment schedule for a mortgage. Amortization does two things: it pays for the interest due on a mortgage, and it pays a portion of the principal, every month.
Amortization is a little more complicated than it might initially appear to be. A common misperception is that one can calculate the monthly principal and interest (P & I) payment by multiplying the interest rate by the loan amount. It is, however, not quite that easy.
How does an Amortization Schedule work?
The borrower's monthly payment (known as the mortgage's amortization), is calculated with three factors:
- The loan's principal balance - in other words, the original loan amount
- The interest rate
- The number of amortization periods - in other words, the number of years over which your loan will amortize (for example, for a 30-year fixed mortgage, there are 30 amortization periods).
The following formula is used to calculate monthly payments, and hence the amortization schedule:
MP= LB [(I (1+I), ((1+I) n-1)]
- MP is the monthly payment
- LB is the principal loan balance
- I is the annual interest rate
- N is the number of amortization periods
When your lender calculates your loan's amortization, or when you use an online amortization table, this formula provides the basis of those calculations. While there may be some differences in calculations based on whether your loan is a fixed-rate or an ARM, the formula remains the same.