What is amortization?
Amortization is simply a technical term used to describe the process of paying down a mortgage debt over time through regularly scheduled payments. Every time you make a mortgage payment, a set percentage of the money goes toward the principal owing on the loan and a set percentage goes toward the interest that's accrued over time.
An amortization formula is used to determine how long it will take you to pay off a loan of a certain amount, given the loan term and interest rate. Generally speaking, larger amounts of your payments are applied to the interest in the early portion of your mortgage, with more money going toward the principal as you near the end of the term.
Types of Loan Amortization
There are many different types of loan amortization, including linear, declining balance and bullet amortization, as well as annuity amortization and negative amortization. Of these, linear and declining balance amortization are usually applied to home mortgage loans.
Mortgage amortization schedules always run chronologically and assume that your first payment will be made the month following the creation of your mortgage. In most cases, the final payment will be of a different amount — either smaller or larger — than the rest.
The proportion of the payment that goes toward principal and interest varies from lender to lender. In some cases, as much as 80 to 90 percent of your early payments can go toward the interest, with this percentage tapering off as you amortize your loan.
How to Use an Amortization Calculator
Free amortization calculators are widely available online. They help you plan your financial future by breaking down your amortization schedule in easy-to-understand terms.
To use one, you need several pieces of information, including the total amount of your mortgage loan, the amount of money you'll be putting as a down payment, the length of the loan term (in years) and the interest rate you're being charged. These factors vary, depending on whether you are getting a fixed rate mortgage or a variable rate mortgage.
All you need to do is plug the required information into the given fields, and the amortization calculator will automatically return your payment data. It will detail the declining principal that's outstanding on the loan as you pay it down, and it will tell you how long it will take you to own your house free and clear.