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Posted by on Apr 11, 2014 in Tips |

Understanding Amortization

Understanding Amortization

If you are purchasing a home or have already bought a home and are paying on a mortgage you have probably heard the term amortization.  Some of us may already know what amortization is and understand how it works however most of us that are new to the world of mortgage loans may not have a clue as to what this is. 

What Is Amortization

When we are speaking of amortization it is most commonly referred to when discussing a mortgage loan.  However all loans will have an amortization schedule associated with them.  Amortization can be defined as an amount of debt that is paid back through installment payments where there is a set date for the loans for people with bad credit to be paid off in full.  All automobile loans and mortgage loans will come with an amortization schedule.  When speaking of a credit card you will find that there is not an amortization schedule associated with these for the simple fact that they are a revolving loan.  What this means is that there is not a specific date that the credit card will be paid in full.

What Does This Mean For The Borrower

As a borrower amortization means that you are agreeing to pay a set amount of interest on the amount of money that you are borrowing.  You will find that almost your entire first monthly payment will go to actually paying interest and not any of the principal amount.  But as you continue to make payments every month your payment will go to interest and principle.  When the amount of interest is smaller more of the payment amount will go towards the principal balance.

As you make more and more payments you will see that the amount of interest being paid every month is lower and the amount of the principle being paid is higher.  When the interest is calculated every month it is calculated against the remaining balance and not on the total balance of the money borrowed.  As you make more payments you will see that the amount of the interest is getting smaller and the total amount of your debt is increased.

Amortization Schedule

If you are having trouble understanding amortization and how it works it might be helpful for you to look at an amortization schedule.  This schedule might give you a clearer understanding of the process.  Amortization is not an easy calculation but by looking at the amortization schedule you might you might be able to understand the process.  You should be able to see when the payment will increase and decrease on the principal.  The good news is that the longer you have the loan the smaller both the principal balance and the interest balance will decrease.

Conclusion

If you are a financial wizard and have a financial background you might find that amortization is not confusing at all.  However if you are an average person you might find that the calculation is difficult to understand and can be very confusing.  The good news is that there are many websites that have calculators to help you breakdown your payments over the life of your loan.  This can be a big help.

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