An amortization calculator provides buyers with a comprehensive and complete breakdown of their mortgage payments over the life of the mortgage loan. Each monthly payment is explained in greater depth, which tells you exactly how much money is going toward the different parts of your loan.
In total, your mortgage consists of four payments; the principal, the interest, property taxes, and insurance. Borrowers pay off their loan’s total cost over time, with each payment funding different areas of the loan. You can reference an amortization calculator to become more familiar with your mortgage loan and prepare yourself for the process.
What is Amortization?
Amortization describes how your monthly payments are applied to pay off the main components of your mortgage, meaning the principal balance and interest. Payments made toward the amount you borrowed are applied to the principal of the loan itself, whereas the interest payments go directly to the lender.
It’s important to realize that the payments you make are not exclusively applied to the amount you borrowed — they are combined with the loan’s other fees to establish the total cost of your mortgage.
A loan’s amortization schedule is a full breakdown of how the money is applied to the complete loan package across the entire term of the loan. An amortization schedule identifies the financial pathway of every mortgage payment.
How is an Amortization Schedule Calculated?
On a 30-year loan, the amortization schedule would factor in all 360 monthly mortgage bills. However, not every payment has the same division of funds. The ratio of funds that go to the principal and those that go to the interest adjusts over time. This is because the percentage of interest changes each time a payment is made to decrease the balance. At the beginning of your repayment period, when you have the largest balance, your payments include the most interest. As you pay off the balance, the interest you pay decreases. Borrowers pay off most of their owed balance at the end of their loan’s lifecycle.
How Does an Amortization Calculator Work?
An amortization calculator is a tool that buyers can use to evaluate their potential amortization schedule. Amortization calculators use the loan’s terms, interest rates, and principal to calculate how the monthly payments will adjust as the principal amount reduces over time. The calculation occurs month by month, since each payment will impact the rest of the repayment schedule. This is how amortization calculators are able to accurately examine a loan’s amortization. The schedule’s accuracy will depend on how the input values reflect the actual loan.
Lenders will determine the final loan terms and amortization schedule during the underwriting process. Buyers will obtain their official amortization schedule when they receive their final mortgage documents from their lender. But, an amortization calculator can help buyers have an accurate picture of their mortgage loans in advance, specifically what the month-to-month payments will be like.
How to Calculate Amortization On Your Own
Since mortgage amortization schedules are based on each successive month, the biggest value that a digital amortization calculator offers buyers is its ability to calculate hundreds of loan payments in seconds. Buyers can calculate amortization on their own by following this five-step formula:
- Divide your interest rate by 12 to calculate your monthly interest rate.
- Calculate your interest payment by multiplying your monthly interest rate by the loan’s current balance.
- Calculate the principal payment by subtracting the interest payment from your total monthly payment amount.
- Calculate your remaining balance by subtracting your principal payment from your current total balance.
- Repeat this process with the new current balance each month to calculate each individual payment. Always use the numbers from the previous month’s calculations to gauge the next month’s amortization. For example, January’s payment needs to be calculated using December’s total remaining principal balance.
If you work with an amortization calculator that also factors in insurance and taxes, the calculations will be accurate to your loan as they reflect the complete loan package. Buyers who are working with amortization calculators that do not factor in insurance and taxes need to be aware that these additional expenses will be present in the amortization schedule they receive from their lender.
Why Buyers Should Care About Amortization
According to Credit Karma, 83% of your mortgage payments made in the first year of a 30-year loan term go toward paying down your interest. In comparison, only 3% of the payments made in the last year of the loan go toward interest. Because of the amortization schedule, little equity is generated in the early years of homeownership. Buyers who are interested in building equity in their home to maximize their real estate investments need to understand how their payments are being divided over the years of their loan’s terms.
Understanding how your loan affects your broader scope of ownership, as well as the monthly payments, is a best practice for home buyers. Amortization calculators are a critical tool that can be used to gauge the long-term position buyers will be in as new homeowners. If you’re interested in trying out a mortgage calculator to compare prospective rates and offerings between lenders, click here to try ours.
