Mortgage Amortization: FAQ For Homebuyers
WHAT IS MORTGAGE AMORTIZATION?
WHAT TO CHECK | WHAT TO ASK | WHY IT MATTERS |
Principal Application | How do I designate this as a principal-only payment? | Extra money saves interest only if it reduces principal |
Future Payment Credit | Will this advance my next due date instead? | A payment credited towards next months payment does not accomplish what you intended |
Prepayment Penalty | Does my loan impose any penalty for early payment? | Loan terms may vary |
Statement Verification | Where will the principal reduction appear on my statement? | Allows you to confirm the payment was processed correctly |
Recast Elligibility | Can my payment be recalculated after a substantial principal reduction? | A qualifying recase may lower the required payment |
Current Loan Status | Are all scheduled payments still current? | Extra money may be applied differently if the loan is delinquent |
Payment Method | Must additional principal be submitted separately? | Servicers use different payment systems and instructions |
Amortization is the process of paying off a mortgage through scheduled payments over a specific period of time.
With a typical fixed-rate mortgage, each payment includes both principal and interest. Principal is the amount borrowed. Interest is the lender’s charge for lending the money.
Although the scheduled principal-and-interest payment generally remains the same, the way that payment is divided changes throughout the life of the loan.
WHY DOES MY MORTGAGE BALANCE DECREASE SO SLOWLY AT FIRST?
During the early years of a mortgage, the outstanding principal balance is at its highest. Because interest is calculated using that balance, a larger portion of each early payment goes toward interest.
As the principal balance decreases, less interest accrues. More of each later payment can then be applied to principal.
That is why a homeowner may make thousands of dollars in payments during the first year but see the principal balance decrease by a much smaller amount.
IS THE LENDER COLLECTING ALL THE INTEREST FIRST?
Not exactly.
This is a common way people describe amortization, but the lender does not simply collect every dollar of interest before allowing the borrower to begin paying principal.
Each regular payment on a typical amortizing mortgage includes both interest and principal. However, because the balance is highest at the beginning, the interest due is also highest. That leaves less of the payment available to reduce principal.
As the balance falls, the interest portion generally becomes smaller and the principal portion becomes larger.
WHAT IS INCLUDED IN MY TOTAL MONTHLY MORTGAGE PAYMENT?
A total monthly mortgage payment may include:
• Principal
• Interest
• Property taxes
• Homeowners insurance
• Mortgage insurance
Only the amount applied to principal reduces the mortgage balance.
Property taxes and homeowners insurance are costs of owning and protecting the property. They may be collected through an escrow account, but those payments do not reduce the loan balance.
WHAT IS AN AMORTIZATION SCHEDULE?
An amortization schedule shows how each scheduled payment is divided between principal and interest. It also shows the expected loan balance after each payment.
The schedule allows a borrower to see:
• How much interest will be paid over time
• How slowly the principal may decrease during the early years
• How the principal portion increases later
• The effect of making additional principal payments
A borrower can ask the lender or mortgage servicer for an amortization schedule. Online mortgage calculators can also provide estimates, but the actual loan documents and servicer records control.
CAN ONE EXTRA MORTGAGE PAYMENT REALLY MAKE A DIFFERENCE?
Yes, provided that the additional money is applied directly to principal.
Reducing principal early lowers the balance against which future interest is calculated. That can reduce the total interest paid and shorten the time required to repay the mortgage.
For example, assume a borrower has a $300,000, 30-year fixed-rate mortgage at 6.5 percent. The monthly principal-and-interest payment would be approximately $1,896.
If that borrower makes one additional principal-and-interest payment each year and the servicer applies it directly to principal, the mortgage could be paid off approximately five years and eight months early. The borrower could save roughly $84,000 in interest.
This is only an illustration. Actual results depend upon the loan terms, payment timing, remaining balance and the servicer’s application of the payment.
DO I HAVE TO MAKE THE EXTRA PAYMENT ALL AT ONCE?
No.
A borrower who cannot comfortably make one large additional payment may divide that amount across the year.
In the example above, one additional annual payment of approximately $1,896 could be divided into twelve additional monthly principal payments of approximately $158 each.
A borrower may also choose to apply part of a tax refund, work bonus or other occasional income toward principal.
The essential point is not how the borrower accumulates the extra amount. The essential point is making sure the servicer applies it directly to principal.
HOW DO I MAKE SURE AN EXTRA PAYMENT IS APPLIED TO PRINCIPAL?
Contact the mortgage servicer before sending the additional money.
Ask:
1. How do I designate an additional payment as principal only?
2. Will the payment immediately reduce my principal balance?
3. Will it instead be credited toward a future monthly payment?
4. Where will the principal reduction appear on my statement?
Some online payment systems contain a separate field marked “additional principal.” Other servicers may require different instructions.
After making the payment, review the next statement to confirm that it was credited correctly.
WILL AN EXTRA PRINCIPAL PAYMENT REDUCE MY REQUIRED MONTHLY PAYMENT?
Usually, it will not.
An additional principal payment generally reduces the loan balance and may shorten the repayment period, but the regular scheduled payment ordinarily remains the same.
Some lenders permit a mortgage recast after a substantial principal reduction. A recast recalculates the monthly payment using the lower balance and remaining loan term.
A recast is different from refinancing, and not every mortgage qualifies.
COULD I BE CHARGED A PREPAYMENT PENALTY?
Small, periodic principal payments do not ordinarily trigger a prepayment penalty, but borrowers should not assume that every loan is the same.
Review the promissory note and mortgage documents. Ask the lender or servicer whether the loan contains a prepayment penalty and what circumstances would trigger it.
DOES PAYING EXTRA PRINCIPAL REDUCE MY PROPERTY TAXES OR INSURANCE?
No.
Paying additional principal reduces the mortgage debt. It does not directly reduce property taxes, homeowners insurance premiums or other expenses associated with owning the property.
Even after the mortgage is fully paid, the property owner remains responsible for taxes and insurance.
WHY CAN MY TOTAL MONTHLY PAYMENT CHANGE IF I HAVE A FIXED INTEREST RATE?
A fixed interest rate generally keeps the scheduled principal-and-interest payment stable. It does not freeze every other part of the total monthly payment.
The amount collected for escrow may change when property taxes or insurance premiums increase or decrease. Mortgage insurance may also affect the payment.
A change in the total amount due does not necessarily mean that the fixed interest rate changed.
DOES REFINANCING START AMORTIZATION OVER?
Refinancing replaces the existing mortgage with a new loan. The new loan receives its own repayment term and amortization schedule.
If a homeowner who has already paid on a mortgage for several years refinances into a new 30-year loan, the repayment period may be extended. The homeowner may obtain a lower interest rate or monthly payment but still pay more total interest if the debt remains outstanding for many additional years.
A refinance should therefore be evaluated using more than the new monthly payment. Consider the interest rate, closing costs, new loan term, total projected payments and how long the homeowner expects to keep the property.
SHOULD EVERY HOMEOWNER MAKE EXTRA PRINCIPAL PAYMENTS?
Not necessarily.
Paying additional principal may be beneficial, but it should not leave the homeowner without emergency savings or unable to pay higher-interest debts and necessary living expenses.
Money paid toward mortgage principal becomes home equity. That value may not be easily accessible when an emergency occurs.
The right decision depends upon the homeowner’s mortgage terms, other debts, available savings and overall financial circumstances.
WHERE CAN I FIND THE TOTAL COST OF MY MORTGAGE?
The Closing Disclosure provided for many residential mortgage transactions includes loan calculations showing the projected total of payments and finance charge.
Borrowers should review more than the purchase price and monthly payment. They should also consider:
• The interest rate
• The loan term
• The total projected interest
• Mortgage insurance
• Prepayment provisions
• The projected balance after several years
• Whether the loan contains a balloon payment or adjustable rate
The lowest monthly payment is not always the least expensive loan.
WHAT IS THE MOST IMPORTANT THING TO REMEMBER?
Interest is calculated using the amount you still owe.
During the early years, you owe the most, so a larger part of each payment goes toward interest.
When you reduce principal early, you reduce the balance against which future interest is calculated.
Before sending additional money, confirm that your loan permits it and instruct the mortgage servicer to apply the payment directly to principal.
For a more detailed explanation and a full numerical example, read “Why Your Mortgage Balance Barely Moves—and What One Extra Payment Can Do.”
This post provides general educational information and is not individualized legal, tax or financial advice. Mortgage terms vary. Review your loan documents and consult your lender, mortgage servicer or appropriate professional before making financial decisions.
Download our FREE Amortization Calculator, Payment Tracker, Extra Payment Comparison Table and Plain-English Guide, created by Judith L. Hampton, licensed Louisiana Attorney here:
Shop our self-service real estate templates, drafted by Judith L. Hampton, licensed Louisiana attorney, below. Purchase, Download, Fill In Your Information and Complete Yourself With No Attorney Fee. (Recommended for simple matters only. If you are unsure of what you need or what to do with the document, please seek legal advice before purchase or use.)
Judith L. Hampton
Attorney-at-Law
Hampton Law Firm
Comments