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Learn what an amortization schedule is, see an example of what it looks like, and find out why it is important when getting a mortgage loan.
If you're in the market for a mortgage you will undoubtedly come across technical finance terms such as amortization. Although it's a little difficult to spell and even pronounce, amortization is quite easy to understand and very powerful once you know what it can do for you.
Amortization is the paying off of debt with a fixed payment schedule in consecutive installments over a specific period of time. As a borrower you will most likely encounter a amortization with a mortgage or auto loan.
Credit cards, for example, don't amortize because there is no predetermined payoff period. You can borrow money more than one time and you can make irregular payments of various amounts to pay off your balance.
An amortization schedule shows you every single payment you make according to your amortization period.
Specifically, an amortization schedule is a table of periodic loan payments which show you the amount of principal and interest paid each month or year. The table will show you exactly how your loan will be paid off by the end its amortization term.
Amortization payments are fixed and designed so that the majority of money you pay on your first payment goes towards interest, while the majority of money you pay on your last payment goes towards principal.
For example, let's say you have a 30 year $300,000 fixed mortgage at a 4% interest rate:
Your very first monthly payment will be $1,432 of which $432 will be applied towards principal and $1,000 will be applied towards interest. In contrast, your very last monthly payment of $1,432 would be allocated as $1,427 to principal and only $5 towards interest.
Below the last payment line of the schedule, you will see a total for the interest and principal payments for the entire loan term.
Tip: When you apply for a new loan lenders are not required by law to give you an amortization schedule. This is why it's important to ask your lending professional for one before you agree to move forward with the loan. For quick reference, use this amortization schedule to easily calculate your loan payoff schedule.
It's important to note that every time you refinance your existing mortgage, the amortization schedule starts all over again. Because early payments are designed to go towards interest and then gradually go towards principal, by refinancing you will be extending the time it takes to pay off your loan.
To explain, let's look at the 30 year $300,000 fixed mortgage at 4% example:
By refinancing you just increased your loan balance and lost 4 years of amortization. Now, you have to start over repay 4 years of interest that you'll never get back!
Although a refinance can be very useful for people in many cases, you need to make sure it makes sense. Be sure to weigh out all the options, consider your amortization schedule and make a smart decision.
If you're in the market for a new mortgage, the amortization schedule will help you better understand the exact details of your monthly mortgage payments, when your mortgage will be paid off and give you a tool to compare different loan options between lenders.
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