Amortization. Big information. And an important information in the loan world. It doesn’t matter whether you’re getting a loan for a boat, car or home – it’s an important concept to grasp. Of course, I’m going to focus on how understanding your loan amortization is important when considering home loan financing. It can average a big difference in the amount of cash you shell out toward your home mortgage over time.
Amortization is the repayment, systematically, of calculated principal and interest to a lender over a designated period of time. Calculating an amortization schedule is a not an easy task. Thankfully, some really smart mathematical whizzes came up with tools that do it for us automatically. You can just punch in the numbers and print out a schedule. You can find online tools to assist you if you’re sitting at home and disinctive to see your current schedule. Or dig by your folder of loan closing documents. You should be able to dredge up a copy. And if you’re considering a home loan, your lender should be able to provide you with amortization schedules for different financing scenarios.
What does an amortization schedule look like? Pages and pages of numbers that finally end up reflecting your loan balance paid off. It points out to you, payment by payment, exactly how much of your monthly loan payment is directed toward principal reduction, lender collected interested, and escrow payments (if you have your lender pay your taxes and insurance for you). Also, you can see on the Truth In Lending statement just exactly how much money you’ll be paying out of pocket over the complete amortization period if you only make your minimum monthly payments. It’s enlightening. Or some say, nauseating. The fact of the matter is that 85% (or more) of your house payment on the first pages of the amortization schedule go mainly toward interest fees. It’s not till the back few pages that your payment really starts chipping away at principal.
So how can you avoid paying so much more money back to a lender than you’re truly borrowing? By making additional principal payments monthly. You may be surprised to know that by paying additional money towards principal monthly, (make sure to write a separate check and mark it “principal payment”), you can chip off years of your loan repayment schedule and keep money in your pocket. for example, if you have a 30 year fixed mortgage for $150,000 at 6%, paying an additional $50 per month will save you $26,673 in interest and pay off your loan approximately 4 years early. You can also unprotected to similar results by making a lump sum principal payment a year (maybe budget part of a yearly bonus toward this goal). Why this scenario works is that by reducing the principal more quickly over time, there’s less of a lump sum debt to calculate interest against. Make sense?
So stay in once a month, skip that new pair of shoes or Wii game. Put the money toward your principal. Or when pre-qualifying for a home, include an additional principal payment in your budget. Lower your “payment comfort level” a tad to allow for an additional monthly principal payment you intend to make. You’ll really see the assistance of doing so in the long run!