If you don’t understand amortization tables, you’re not alone. But if you’re ever planning to borrow money to buy real estate, understanding amortization tables is essential. Why’s that?
Amortization tables, also called amortization schedules, describe the repayment of money that’s borrowed. They set up, month by month, the interest and principal amounts that are due to the lender lender.
Example of Amortization Table
When closing on a home mortgage, the lender provides a long document that lists, line by line, each and every payment in the mortgage and how it will be allocated.
For a 30 year mortgage, there will be 360 payments (12 payments per year x 30 years). For fifteen year mortgages, there will be 180 payments (12 payments per year x 15 years).
Therefore, the lender is obliged to show how each of those 180 or 360 payments will be allocated to principal and interest.
Here’s an example of a mortgage for a modest house. If we borrowed $150,000 at 6% interest, this is what the amortization schedule looks like. To create this, I used bankrate.com’s excellent amortization calculator.
Amortization Schedules Help You See Where Your Money Is Going
Let’s look more closely at the amortization table over years. This reflects the proportion of loan payment that goes toward interest at 6%, over 30 years.
In Figure 1 if you look closely at the very first payment of this mortgage, $750 of the total payment goes toward interest. That’s 84% of the payment.
After one year, 81% of the payment goes toward interest.
In a 30 year mortgage at 6%, it would take the borrower 19 years to reach the point where more of the payment would go toward principal than interest. Most people don’t live in their homes for 19 years anymore.
In fact, according to RedFin and The New York Times, most homeowners stay in their homes for 13 years as of 2022[1]; however, tenure in homes is regional and city-dependent. In California, for example, property tax increases are limited by favorable law, Proposition 13, which limits property taxes and limits the frequency of reassessment to when homeownership changes.[2]
Amortization Schedules for Lower Interest Mortgage Loans
For lower interest mortgages, it’s important to note that the monthly payment of principal interest is lower. This is in order to achieve a 30 year amortization. See Figure 3 below.
Rather than having an $899 payment, the payment is nearly two-thirds lower at $632 monthly.
Does the time to that proportional shift in favor principal payoff occur at the same time in a 3% mortgage as a 6% mortgage?
Absolutely not.
For the same home, purchased with a $150,000 mortgage, but now with a 30 year mortgage at 3% interest, the payoff terms are much more favorable. The time when monthly payments are weighed more in favor of principal happens at year 8; at 6%, this happens at year 19.
The reason it still takes 30 years to pay off this loan despite the reduced interest charge is because the monthly payment has been set lower.
If I changed the monthly payment from $632 to $899, which is the minimum payment for the mortgage borrowed at 6%, how long would it take to pay off this mortgage?
It would take only 18 years rather than 30. The total interest paid in that case would be $44,000. This saves $33,000 of interest and 12 years of time compared to paying the loan at the lender’s minimum payment. Of course, a 3% loan will always have a lower total interest than a 6% loan. The total interest paid for a 6% loan is $173,000, even with the same monthly payment $899.
While many homeowners who borrow at 3% may choose to invest rather than pay off the mortgage, this should be a thoughtful decision. Borrowers should use amortization calculators to determine how additional payments to principal impact the time and expense of their total mortgage.
Do Amortization Schedules Change Based on Loan Value?
For the same loan term and loan interest rate, amortization schedules are created such that the proportion of interest per year is about equivalent.
For example, if I purchased a home with a loan for $1,000,000 rather than for $150,000 as I am showing above, would Figure 4 change?
The answer is no. The proportion of interest in amortization schedules remains the same even when the total principal value changes. However the $1,000,000 mortgage will have a much higher absolute dollar value of interest.
The monthly payment on a $1,000,000 mortgage financed at 6% is $5,996. Since we know that 84% of that initial year’s payment goes to interest, we see that only about $1,000 of each payment will go towards principal payoff.
Should you pay off your mortgage early?
The answer to this question changes depends on circumstances.
The homeowner who has borrowed $1,000,000 at 6% is facing monthly payments of $6,000.
Compare this to the homeowner who has borrowed, as above, $150,000 at 3% with monthly payments of $632.
Having a manageable mortgage payment is one of the most important principles of personal finance. Housing will always remain an expense, but it is imperative not to over-reach your income.
Borrowers with higher interest mortgages (over 5%) should use amortization calculators to determine how extra payments will impact the length and cost of their mortgage. They should pay their mortgages down as fast as they reasonably can, so long as they have reasonable cash reserves outside.
After all, you can’t eat your house.
How do you find your amortization schedule?
You can always find your amortization schedule among your closing documents when you signed for your mortgage. The bank will print a many-page document listing each and every payment.
If you don’t have the closing package on-hand, you can always calculate your amortization schedule by using an online amortization calculator. These calculators allow you to enter your total borrowing amount, loan term, and interest rate. Then they’ll return a table and graph listing each payment individually and its proportion of interest and principal.
The advantage of turning to an amortization calculator is the ability to determine the impact of extra payments toward the mortgage. If you purchase a property as an investment, for example, with a goal for loan payoff at the time of (early) retirement, the amortization calculator will help you determine exactly how much to pay towards the loan. Purchasing investment properties and paying them off is a tried-and-true method of achieving financial independence.
The Bottom Line on Amortization Schedules
Mortgage loans use amortization to front-load the interest paid by borrowers. Lenders do this because homeowners usually stay in homes for 13 years. Banks know this and that’s why they structure mortgage loans as amortized loans. If they structured the loan with equal interest payments, they might miss out on more than half of the interest fee!
Nearly everyone can pay off a mortgage, but we should all weigh the decision carefully. Homeowners should not sacrifice the safety of a liquid emergency fund, for example, but consider the unexpected benefit of small, extra payments to the principal.
Thanks for reading.
References
[1] Kolomatsky, Michael. Where Do Home Owners Stay In Their Homes Longest. The New York Times. 24 March 2022. https://www.nytimes.com/2022/03/24/realestate/where-do-homeowners-stay-in-their-homes-the-longest.html
[2] Proposition 13 https://www.boe.ca.gov/proptaxes/pdf/pub29.pdf
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