How does a Mortgage Amortize?
By Ann WhiteA step-by-step guide for understanding the mortgage amortizing process. See how monthly interest is paid off and mortgage principal is gradually reduced.
Like any debt amortization that reduces the initial debt value through equal installments to a eventual zero balance, absent of any form of early repayments, a mortgage is eventually paid off at the end of the loan term via continuous equal monthly payments over the life of the loan. But because any carried mortgage balance at any point of time accrues interests going forward, any periodic payment due must first pay off the accrued interests up to that point, with the remaining portion to pay down the still outstanding principal balance. The same process continues month after month until a zero balance is finally reached. This entire process of reducing an outstanding mortgage all the way to a zero balance is called mortgage amortization.
Equal Monthly Payment
From the lender’s point of view, all future payments made by the mortgage borrower must be discounted back to present time to equal to the amount of the mortgage loan taken out today to reflect the time value of money, namely the interests, and that’s how future monthly payment amount is determined in principle. In other words, any future mortgage payment, say after n months, must be in value equals to what has been compounded for n months from the mortgage today’s value. A financial calculator should be used and the constant monthly payment amount can be easily determined, when the loan value, the loan term, and the interest rate are all given. For example, for a $100,000, 30-year mortgage with a interest rate of 5%, the monthly payment is set to be $536.82.
Monthly Interest Accrued
Once the mortgage starts, interests begin to accrue month after month. Using the same example from above, the interest for the first month, i.e. when the first monthly payment is due, is calculated to be $416.67($100.000*5%/12). After each monthly payment, the outstanding mortgage balance is gradually reduced and therefore the interest for the month after is to be lower and lower. And with an equal payment every month, the portion of each payment made toward the mortgage principal is set to be larger and larger moving forward.
Paying Down Principal and Mortgage Amortizing
Still using the same example. With first month interest of $416.67 and payment of $536.82, the remaining payment of $120.15 is applied toward reducing current mortgage balance of $100,000, resulting in a balance of $99,879.85 for the beginning of the second month, the principal amount on which the interest is to be accrued for that month. This same amortizing process repeats itself until the last resulting principal balance is zero. To find out the total interests paid on the loan without going through the entire mortgage amortizing process month after month, simply add up all monthly payments of $536.82 for 360 months and subtract the principal loan amount of $100,000 from it to arrive at $93,255.20 for total interest paid over the life of the loan.
Related posts:
- How Do I Calculate Principal Reduction On My Mortgage Loan?
- What Is The Pre-Paid Interest On A Mortgage?
- If I Pay More Than My Monthly Payment On My Mortgage, How Is It Applied?
- How Do I Amortize A Home Mortgage?
- How Can I Repay My Mortgage Faster?
