Amortization describes the process of dividing mortgage payments over the term of the loan between interest paid and principal repayment. Mortgages loans are front loaded with interest; this means at the beginning of the loan you are paying more in interest than you are repaying on the principal balance. This works in your favor at the end of the mortgage because the interest is calculated on the remaining balance. The smaller your outstanding balance, the less you will pay in interest. For example, if you were to borrow $100,000 for your home at 6.5% interest over 30 years your monthly payment would be $630. When you make your first payment $540 of the $630 will be paid to interest. This means you will only pay $90 towards the principal balance of your loan. This front loading of interest makes it very difficult to build equity in your home during the early years of your mortgage. Every month that you make a payment the amount of interest you pay is based on the outstanding balance of the mortgage. In this case, the second payment you make the interest will be based on a balance of $99,910. By using an amortization table you will be able to see how the interest amount you pay decreases as the principal balance is paid down. By the time you reach the halfway point in repayment of the mortgage, you will have made 256 monthly payments over the course of 21 years. The remaining balance will be paid back in 9 years. The fact that you will not pay back half of a 30 year mortgage for the first 21 years is a strong case for making bi-weekly mortgage payments. By making bi-weekly payments you can significantly reduce the amount of interest paid over the life of the mortgage, and pay off the balance much faster. |
