Here's how an amortization schedule can keep you on track to paying off your mortgage.
What does amortization mean?
Amortization is the process of paying off loan payments over a set period of time, instead of just paying off a debt all at once.
You are likely already very familiar with this concept. In fact, you are likely already participating in an amortization schedule, perhaps through making monthly payments for your car loan or student loans.
However, the most common kind of transaction that requires periodic payment is a real estate transaction. Some homebuyers purchase a property all cash, which means that they do not need any financing. However, the majority of Americans need financial support to purchase a home.
Because of this, they borrow money from a mortgage lender. This lender could be a retail bank, a mortgage bank, a mortgage broker, or another source of their choosing. The principal amount is the original amount of money they borrow.
Once they receive the money and purchase the house, it is unlikely they will have the funds to pay it back right away. So, amortizing the loan is a great idea.
What is an amortization schedule?
An amortization schedule is a schedule that keeps you on track with your mortgage payments.
When you take out a 30-year mortgage (or any fixed-rate mortgage), your lender gives you a calendar. This calendar shows you what you can expect to pay each month for the term of the loan.
You should receive the schedule from your lender when you first take out your loan.
A proper amortization schedule should also always divide each monthly payment into the categories of “principal” and “interest.” This way, you can keep track of exactly how much of your loan balance is principal payments and what is “extra,” i.e. the interest.
The schedule should also always include a note about the outstanding balance of your loan as you progress through the loan term.
Why should you pay attention to the schedule?
Your lender will calculate your amortization schedule for you; however, it is important to pay attention to your payment schedule.
Avoiding going on autopilot is important for many reasons. The most important is that it's very easy to see the benefits of making extra payments to reduce your principal balance at a faster rate.
An amortization schedule will show you how the interest rate you pay on your mortgage can change each month based on the remaining amount of principal. You can view this on a monthly or yearly basis.
While your monthly mortgage payments do not change unless you officially refinance your mortgage, you can still choose to pay off your loan early with additional monthly payments.
What happens if you refinance your mortgage?
When you first start making mortgage payments, most of the payment is allocated toward interest, while a smaller portion of it goes toward the principal balance. As you near paying off the loan entirely, this balance switches.
When you first buy a property, you might not care too much about this allocation. However, through the years, you might want to refinance your home, or maybe even sell it. Because of this, you will need to know more about the allocation of your money in each payment so you can more accurately estimate your home’s equity.
If you decide to refinance, keep in mind if you keep the same duration of your fixed-rate mortgage, you could end up paying more interest than you actually need to.
This means that if you refinance a 30-year mortgage with another 30-year mortgage after 10 years, you’ll be paying interest on the home for 40 years. Definitely not an ideal situation to be in.
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