Understanding amortization

Amortization helps borrowers repay their loans faster. It is essentially a repayment schedule that initially devotes a large part of your mortgage payment toward the loan interest.

You may be wondering why you wouldn’t want to pay down the principal first. The answer is that amortization allows your mortgage payments to stay the same from year to year. If you paid the principal first, you would probably be required to make large payments at first, with smaller payments toward the end. Such a system is not ideal for most borrowers.

Payments that change make it difficult to draw up a long-term budget. On the other hand, stable mortgage payments mean never having to be surprised or to re-budget.

For amortization to work, a stable interest rate is necessary. Therefore, it is only available with fixed-rate mortgages. Before you even begin to repay that fixed-rate mortgage, your lender will crunch numbers to determine exactly how much interest will build up over the term of your loan.

The accumulated interest, combined with the money you borrowed in the first place, will be spread over the term of the loan. That is how your lender arrives at the amount of your mortgage payment.

You will be given a schedule that essentially shows you what will be paid when. In other words, the amortization schedule details the amount of your mortgage payment which goes toward the interest, as well as, the amount which goes toward the principal. Though these amounts may vary from month to month, the mortgage payment itself always stays the same.

You should be aware that amortization does mean that it will take some time to build equity in your home.