When you make a mortgage payment, part of each payment goes toward reducing the principal (the original amount you borrowed), and part goes toward interest (the cost of borrowing). Mortgage amortization determines how each payment is divided between principal and interest so that payments remain equal throughout the loan’s term.
It’s important to understand mortgage amortization because it affects how quickly you can build home equity and may influence key decisions, such as how long of a loan term to choose, the amount of your down payment, and whether to refinance. We’ll cover how mortgage amortization works, how to calculate amortization with a standard formula, and how to change your amortization schedule.
What is mortgage amortization?
“Put simply, mortgage amortization is the process of gradually paying off your home loan over time through monthly payments that cover both the loan amount and interest,” says James Sias, head of mortgage lending and indirect dealer services at Fifth Third Bank. In the early years, most of your payments go toward interest. As you make each payment, the principal balance decreases, which in turn reduces the amount of interest due with each remaining payment. Amortization is the industry standard across most loan types.
Mortgages have set term lengths and either a fixed or adjustable interest rate. For fixed-rate loans, which means the rate and monthly payment won’t change, lenders typically provide an amortization schedule. The schedule is a table showing the amount of each payment that goes toward principal and the amount toward interest, and the remaining balance after each payment.
Keep in mind
This calculation is only consistent for fixed-rate loans. If you have an adjustable-rate mortgage, your interest rate can change over time, which means your monthly payment amounts can fluctuate, too.
How to calculate amortization
Lenders use a formula to calculate mortgage amortization that includes the following variables:
- M = monthly payment
- P = principal
- r = monthly interest rate (annual rate divided by 12)
- n = total number of payments
M = P x r x (1 + r) n / (1 + r) n -1
To calculate the fixed monthly payment on a $300,000, 30-year mortgage with a 6% annual rate, you would plug in the numbers as follows:
M = (300,000) x (0.06/12) x (1 + (0.06/12)) 360/ (1 + (0.06/12))360 -1
You arrive at a monthly payment of $1,798.65.
Each month, you can calculate the interest payment amount based on the outstanding principal. For example, at the beginning of the loan, the principal is $300,000. Keep in mind, the amount of interest you pay monthly will decrease.
- Principal x monthly interest rate = interest payment
- $300,000 x (0.06/12) = $1,500 (for the first monthly payment)
The remaining portion of the fixed monthly payment goes toward reducing the principal.
- Monthly payment - interest payment = principal payment
- $1,798.65 - $1,500 = $298.65 (for the first monthly payment)
You can then calculate the new principal balance based on the most recent payment toward principal.
- Previous principal balance - most recent principal payment = new principal balance
- $300,000 - $298.65 = $299,701.35
Repeat this process each month to see how the monthly payment will be divided between principal and interest.
Amortization schedule example
Amortization schedules are often presented monthly, but the table below shows an annual summary of an amortization schedule for a $300,000, 30-year, fixed-rate mortgage with a 6% interest rate.
Can you change your amortization schedule?
Yes, you can change your amortization schedule through various methods. Here are the most common:
Make biweekly payments
Making biweekly half-payments instead of full monthly payments accelerates the amortization schedule. A half-payment made every two weeks would equal one extra monthly payment each year. For example, a $1,500 mortgage payment made 12 times in a year adds up to $18,000, whereas 26 half-payments of $750 apiece add up to $19,500.
Good to know
Making biweekly half-payments every month instead of one full monthly payment can save a significant amount of money on interest. For example, on a $300,000 loan at 6%, making biweekly payments of $899.33 vs. one monthly payment of $1,798.65 could save $76,925.40 in interest over the life of the loan.
Pay extra toward principal
Add extra money to your monthly payment and instruct your lender to direct it toward your principal. Similarly, you could make an annual lump-sum payment using an annual bonus, tax refund, or other windfall. Use an extra payment calculator to see how additional principal payments could help you pay off your mortgage faster and save money on interest.
Refinance into a shorter-term loan
This strategy typically makes the most sense if you can qualify for a new loan at a lower interest rate. Make sure you plan to stay in your home long enough for the refinance to be worth the upfront expense.
Although you typically pay closing costs for the new loan, you may be able to refinance your mortgage with no closing costs. Instead of being charged upfront, the costs can be added to your loan amount or factored into your interest rate. In either case, the closing costs don't vanish — you either pay more in principal or more in interest.
Recast your mortgage
Mortgage recasting involves making a large lump-sum payment — typically 20% or more of your remaining balance — and having your lender re-amortize the loan based on the new principal balance. Not every lender offers recasts, and recasting is not typically an option for government-backed loans like FHA mortgages. You may also pay a re-amortization fee.
The lump-sum payment might not be feasible for every homeowner, but the process is typically quick with no credit check or home appraisal.
FAQ
Does mortgage amortization include taxes and insurance?
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What is negative amortization?
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Do extra payments reduce principal or interest?
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Can refinancing reset mortgage amortization?
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