What is an Amortization Schedule? How Does Your Mortgage Work

by Evan

I received a painful reminder a few weeks ago when I made my first mortgage payment on my new home about the wonders of how a traditional 30 year mortgage works with regard to the allocation of interest vs principal payment. I quickly remembered that mortgage literally means death pledge in French.

How do Traditional Mortgages Works? What is an Amortization Schedule

Most people are pretty familiar with the idea of what having a mortgage means. You bought a house and since you didn’t have all that money up front you are going to finance it over a period of time. In the US that usually means every month for 30 years you are going to send into the bank the same equal payment. What most people do not understand is how the actual finances work behind the scenes. While the payment is the same the amount being applied to principal and the amount being applied to interest change slightly. The interest received by the bank is front loaded! I think this can be better seen with an example.

Reviewing my 30 year Fixed Mortgage’s Amortization Schedule

Let’s take my recent home purchase as an example. I purchased my main residence on August 8, 2019 with a 30 year note with an original principal balance of $649,800 and an interest rate of 3.85%. This provides a snapshot view of:

I mainly use DinkyTown for my mortgage calculator (terrible name but amazing website) but if you were feeling so inclined you could use the guide provided by The Balance to create your own amortization table and schedule in excel or google sheets:

The payment is calculated by taking

Assume you borrow $100,000 at 6 percent for 30 years, to be repaid monthly. What is the monthly payment (P)? The monthly payment is $599.55.

Calculate the following values so that you can plug them into the payment formula:

– n = 360 (30 years times 12 monthly payments per year)

– i = .005 (6 percent annually expressed as .06, divided by 12 monthly payments per year

– (For more details, see how to convert percentages to decimal format)

– D = 166.7916 ({[(1+.005)^360] – 1} / [.005(1+.005)^360])

Plug the numbers into the payment formula as follows:

Loan payment = $100,000 / 166.7916 = $599.55

 You can check your math with the Loan Amortization Calculator spreadsheet.

How Much Interest Do You Pay?

Your mortgage payment is important, but you also need to know how much of it gets applied to interest each month. A portion of each monthly payment goes toward your interest cost, and the remainder pays down your loan balance. Note that you might also have taxes and insurance included in your monthly payment, but those are separate from your loan calculations.

An amortization table can show you—month-by-month—exactly what happens with each payment. You can create amortization tables by hand, or use a free online calculator and spreadsheet to do the job for you. Take a look at how much total interest you pay over the life of your loan. With that information, you can decide if you want to save money by:

– Borrowing less (by choosing a less expensive home or making a larger down payment)

– Paying extra each month

– Finding a lower interest rate

– Selecting a shorter-term loan (15 years instead of 30 years, for example)

While the one time end of the loan snapshot provides information about the payment amount and ungodly amount of interest I would pay if I kept the mortgage and paid the monthly minimum, I don’t think it provides a good enough picture as to the magnitude of the breakdown of the payment scheme. Take a look at interest vs principal payment by year on the same mortgage:

In that first year about two-thirds of the payment went to just the interest ($25,000 of the $36,000 that was paid to the bank)! So if you sell your house in the first few years you basically just paid a ton of interest to the bank barely getting any of that forced savings goodness.

What Happens when a Prepayment is Made to a Mortgage?

So what happens when you send in an extra payment or payments? The extra payment should be a purely principal payment, and as such, the interest on the remaining principal is to be lower (while keeping the payment the same). For example, if I were (and I am) to send an extra $100/month towards my mortgage my payment schedule completely changes:

Or if we were to put it in a table format:

A mortgage is likely a person’s largest debt connected to their largest asset, it is important to have at least a cursory knowledge of how the system works.

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