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If you’ve ever taken on any type of fixed loan, you’ve probably seen the effects of an amortization schedule at work.
An amortization schedule offers a detailed look at your loan payments, and shows how much of each payment goes toward interest versus the loan principal. Knowing this can help you understand where your money is going, your payoff timeline, and even help you make an informed decision on refinancing.
Here’s how you can use amortization to choose the right mortgage and pay off debts more quickly:
Paying Off a Loan Over Time
Amortization is the process of paying off a loan or other debt in regular installments over a given period of time.
For each payment you make, some portion goes toward the principal, or actual loan amount, and some pays down interest. In the beginning, payments will go mostly to interest, but over time, the balance shifts to mostly principal.
Amortized loans can include any loan with standard monthly payments and fixed terms. Most often, amortization is associated with mortgages, but auto or student loans may also amortize.
If you choose an adjusted rate mortgage (ARM), calculating amortization is more complex and must account for interest rates that change over time. Similarly, credit cards are not typically considered amortized loans, since your balance and payments may fluctuate each month.
What Is an Amortization Schedule?
An amortization schedule can help you visualize how each of your payments over time reduce your amount owed over time.
At the start of your payoff plan, the majority of each payment will go toward interest, with a smaller amount chipping away at the principal itself. Over time, though, more and more of each installment will start to reduce the principal as the amount paid toward interest declines.
Each month, you pay the interest that accrues on your outstanding balance. Banks and lenders charge this first in order to recoup the cost of lending to you. But some of each payment must also go toward the outstanding balance, or you’d spend forever paying off the loan.
When that balance is highest, interest grows more quickly. Because mortgage payments are fixed installments, there is less left over to reduce principal after that interest is paid. But as you reduce the principal over time, less interest can accrue on your shrinking outstanding balance each month, allowing more of your fixed payment to go toward the principal as you near the end of your loan’s term.
Using an amortization schedule, you can see month by month exactly how much of your fixed payment is applied to the debt principal versus accrued interest. You’ll also see how your overall balance decreases over time.
How Do You Calculate Amortization?
To calculate your loan’s amortization, there are a few details you’ll need:
- Amount borrowed: This is your principal, or your total amount of borrowed debt.
- Loan term: The length of your loan. For fixed-rate, fixed-term mortgages, this is typically 15 or 30 years (180 or 360 months).
- Interest rate: Your loan’s fixed interest rate. This is the annual interest rate your loan accrues.
- Extra payments: If you make additional payments on top of your regular installment schedule, you can apply them directly to the principal and pay off your loan more quickly. This calculator can show you how extra annual or one-time payments may speed up your debt payoff.
Once you’ve added the details of your loan, input them into the calculator to view your amortization schedule, and adjust as needed to compare different loan terms that may work for you.
How Do You Calculate Monthly Mortgage Payments?
Calculating your monthly mortgage payment can help you determine how much you’ll really be able to afford when you purchase a home. It can also be useful for deciding what type of mortgage loan may work best with how much you’re able to pay.
The equation requires a bit of tricky math, so you’ll probably want to use an online tool. But if you’d rather try it yourself, you can use this formula to calculate your monthly payment (M).
- Begin with your principal loan amount (p).
- Divide your annual interest rate by 12 to find the monthly interest rate (i).
- Multiply your loan term — usually 15 or 30 years — by 12 to calculate the number of total monthly payments over the lifetime of the loan (n).
- Once you have your inputs, use the following formula to calculate your monthly payment:
M = p[(i(1+i)^n)/((1+i)^n)-1]
Don’t forget, while this formula can help you work out your monthly payment, you may still need to account for property taxes, homeowners insurance, or mortgage insurance in your overall estimate.