Do you ever wonder how your monthly mortgage payment is calculated?
…I am buying a house and received a huge package of disclosures from my lender. There’s an amortization schedule table in there with a ton of numbers. My lender said it’s just standard procedure to send them and for me not to worry. Do I need to care about this? And why is less of my money going towards principal at the beginning? Is it their tactic to make more money?
– Writes Kathy
Participants of an amortizing loan (aka a fixed rate mortgage) should get to know the amortization schedule, a table that details each periodic payment and how much of it gets applied to the principal and interest. In order to illustrate what this schedule tells us, let’s start off with an example. A $100,000, 30-year fixed loan at 5% interest will have the schedule as follows:
| Pmt | Principal | Interest | Cum Prin | Cum Int | Principal Balance |
|---|---|---|---|---|---|
| 1 | 120.15 | 416.67 | 120.15 | 416.67 | 99879.85 |
| 2 | 120.65 | 416.17 | 240.80 | 832.84 | 99759.20 |
| 3 | 121.16 | 415.66 | 361.96 | 1248.50 | 99638.04 |
| 4 | 121.66 | 415.16 | 483.62 | 1663.66 | 99516.38 |
| 5 | 122.17 | 414.65 | 605.79 | 2078.31 | 99394.21 |
| 6 | 122.68 | 414.14 | 728.47 | 2492.45 | 99271.53 |
| 7 | 123.19 | 413.63 | 851.66 | 2906.08 | 99148.34 |
| 8 | 123.70 | 413.12 | 975.36 | 3319.20 | 99024.64 |
| 9 | 124.22 | 412.60 | 1099.58 | 3731.80 | 98900.42 |
| 10 | 124.73 | 412.09 | 1224.31 | 4143.89 | 98775.69 |
| 11 | 125.25 | 411.57 | 1349.56 | 4555.46 | 98650.44 |
| 12 | 125.78 | 411.04 | 1475.34 | 4966.50 | 98524.66 |
| … | |||||
| 349 | 510.69 | 26.13 | 94238.74 | 93111.44 | 5761.26 |
| 350 | 512.81 | 24.01 | 94751.55 | 93135.45 | 5248.45 |
| 351 | 514.95 | 21.87 | 95266.50 | 93157.32 | 4733.50 |
| 352 | 517.10 | 19.72 | 95783.60 | 93177.04 | 4216.40 |
| 353 | 519.25 | 17.57 | 96302.85 | 93194.61 | 3697.15 |
| 354 | 521.42 | 15.40 | 96824.27 | 93210.01 | 3175.73 |
| 355 | 523.59 | 13.23 | 97347.86 | 93223.24 | 2652.14 |
| 356 | 525.77 | 11.05 | 97873.63 | 93234.29 | 2126.37 |
| 357 | 527.96 | 8.86 | 98401.59 | 93243.15 | 1598.41 |
| 358 | 530.16 | 6.66 | 98931.75 | 93249.81 | 1068.25 |
| 359 | 532.37 | 4.45 | 99464.12 | 93254.26 | 535.88 |
| 360 | *535.88 | 2.23 | 100000.00 | 93256.49 | 0.00 |
The amortization schedule also tells us that the monthly payment is $536.82, in addition to the amount going towards principal and interest.
The nice thing about this type of loan is that payment is fixed over the entire length of the loan, which makes budgeting much easier. Otherwise, it would be difficult to feel secure knowing that such a big expense each month can fluctuate wildly.
Paying More Interest At The Beginning
Many will be quick to point out that most of your payment at the beginning really only goes towards interest. Don’t worry though. You aren’t being scammed here. Your mortgage rate is fixed, and when the principal is high, the interest is in turn higher at the start. In the above example, you owe $100,000 at the beginning, so the interest you need to pay is a little under $5,000 for the first year. If the monthly payment is $536.82, it’s only natural that most of your payment goes towards servicing the interest. By payment 349 (the last year of your 30 year fixed rate loan), your remaining principal is only $5761.26 and your interest is less than $300. With the same payment of $536.82, most of your payment will be applied to principal.
Paying It Off Early and Your Monthly Obligation
For those who like to pay off their mortgages early, note that the amortization schedule changes as soon as you put more towards your principal than the schedule suggests. There’s a caveat here though. Most lenders will not change your monthly payment obligation immediately following a mortgage prepayment. Here’s what I mean. Using the same example, say you got a bonus and want to apply the $10,000 towards your mortgage. You’d think that as the principal balance drastically went down, your monthly payment should decrease as your amortization schedule is re-calculated. Not so. Many lenders claim that you can get the new (lower) monthly payment if you call to request it, but again, you need to ask, and someone over at the lending facility need to say yes. Otherwise, you still need to pay that $536.82 until your loan balance is $0.
Therefore, paying more than you owe on your mortgage means sending in less (number of) checks in the future, but it doesn’t necessarily mean sending in smaller (lesser amount) checks in the future. Note the difference and plan accordingly before you mindlessly believe that you are always safe prepaying your mortgages.
Refinancing
Whenever rates drop, the ads for refinancing start popping up. The idea of it is to reduce your monthly mortgage payment, but it’s not necessarily a good thing. Sure, you can reduce your payment if the interest rate goes down, but some people also increase the length of their loan. There may be reasons why you would want to do that, but you are for sure paying more interest by doing this. In these instances, an amortization calculator would be helpful because it will show you exactly how much more interest you would be paying.
A Quick Note of Where to Find a Amortization Calculator
To get the numbers in the above example, all I did was a quick search on Google with the search terms “amortization calculator”. All the ones I’ve checked out work, and pretty much provide the same information. Alternatively, those of you who have Microsoft Office can also download their amortization schedule template straight from its official site.
It’s More Than For Fun
Sometimes, seeing these numbers are interesting but the amortization schedule serve a more important function. When I was contemplating all the mortgage options available, I used the calculator to figure out how much of a difference the rates made, and picked the one that I felt gave me the most bang for the buck. At the end, I picked a higher interest rate that gave me a huge up front credit towards closing, which would’ve never made sense if I didn’t have access to the different schedules.
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The amortization schedule will get you an idea of how prepaying some of the principal amount will save you money over time. Though it is best to consult with your financial advisor about whether it’s best to prepay your mortgage or put that money toward something else, such as retirement.
For example, if a home costs $100,000 and the interest rate is 10%, one interest point will be $1,000 and will bring the monthly interest payment to 9%. If you can afford it, home prices remain at an all-time low and selection an all-time high.
It is also helpful if the town is attractive enough to warrant a move there even during a recession.
Yes, I agree absolutely with Shari and let’s start right here. We are poor but we are always working in pain to make banks rich and them families when our children will have no future freedom from loans.
START a REVOLUTION. Demand that the Amortization Schedules be revised. They were created by banks hundreds of years ago and are clearly outdated in today’s market. This is part of the reason why the Borrower is underwater today. The Lenders receive all of their fees upfront and on most schedules, 2/3 of the interest due is paid by year 10 while it takes 20 years for 2/3 of the principal to be repaid. The rules are written entirely in the favor of the Lender only.
Calculate the interest due the same way but amortize the monthly payment based on the same ratio of total interest due versus total principal + interest due. For example, a $100,000 mortgage at 5% for 30 years will yield $93,255.78 in interest (barring any paydown or late payments, etc.). That creates a total debt of $193,255.78 due over 360 months for a monthly payment of $536.82. The interest of $93,255.82 comprises 48% of the debt and the principal 52%, therefore I propose that the monthly payment be divided accordingly also: Principal 52%=$279.15 / Interest 48%=$257.67 to equal $536.82 per month. The Principal is paid down much sooner, enabling the Homeowner to build equity quickly and “stay above water”. A typical Amort. Schedule shows that Pmt 1 = (Prin./Int.) 22%/78% Pmt 120 = 37%/63% Pmt 240 = 60%/40% and the final Payment? Prin. is 99% of the monthly and Int. is 1%
After all, very few Middle Americans or Lower Americans have the ability to shell out 20%+ as a down payment in order to lower the monthly payment in a significant manner. As we have seen most recently, Interest-Only Loans and ARMs have done more damage to the economic health of Homeowners and Financial Institutions than following a conservative “what’s best for the many” approach.
This kind of benefit should be offered only to individuals who held American Citizenship as of, say 12/31/2009 and used ONLY for their Primary Residence. This is not a method to increase an investor’s portfolio. This schedule is not open to foreign investors who want to make a rapid profit. Guidelines must be in place to protect the integrity of the program. Continuous Home Ownership by applicant of the approved property for 5 years or the schedule reverts to a traditional one and they lose their rapid-accrued principal. If they sell it to a verified American Citizen, perhaps they are given a small additional deduction on their tax return for the benefit (nothing large enough to create a biased situation). OR the Buyer, as a Verified American Citizen, can qualify for a discount of some sort or bonus or tax deduction as an incentive for buying from another verified American Citizen. Any new citizens will have to hold citizenship and provide 5 years of tax returns from the year of citienship before they can qualify. This program is designed to give bona-fide American Citizens an economic boost.
Our Military need to receive such a benefit as more than half need government assistance to feed their families each month via food stamps and WIC. These Men and Women exist to Serve and Protect us. The least we can do is house their families comfortably, safely and affordably.
START a REVOLUTION. Don’t walk away from your mortgage. Demand that the schedules be changed to benefit BOTH sides.
Hallelujah!!!!! I agree. I have been trying to make sense of this since I started looking for a house a year ago. How does that formula make sense???? And why is it even legal? It sounds like loansharking to me. I am all for starting a lobbying group to change this practice of the banks collecting their money “off the top.”
We can start with the CFPB and go from there! Let’s get it on!
I also had no idea whether to really go into depth with my amortization schedule either but I feel much better knowing that I’ll have a secure, fixed rate.
Luckily on the internet you can find an amortization schedule/calculator easily. I wonder how we all made it without the internet?
It was always surprising how much of your payment goes to interest in the early years. That is why if you can increase your payment any in the early stages, it is going to help you. Even if just a few dollars, it is going straight to the bottom line.
Since the majority of interest is paid during the first 10-15 years, anything you can do to advance forward on your amortization schedule will pay big dividends.
In your example, if you paid $10,000 towards your mortgage, your monthly payment would stay the same, but…
What you didn’t share is that you would have advanced yourself forward on the amortization schedule by 73 MONTHS.
In your example, you would now owe $90,000 on the loan. And now $160.75 of each payment goes to principle (it was $120.15 before the $10,000 payment).
If you would have paid your normal payment during the first 73 months of your mortgage, you would have paid $28,211 in interest charges. So when you ‘invested’ $10,000, you got a tax free $28,211 return.
And you would only have 24 years to pay on your mortgage, instead of 30.
So which lender did you choose and why?
I chose Bank of America, because they had the best rate/up front credit combination. I would’ve preferred Wells Fargo, because I bank there and the process seemed less cumbersome. Since my accounts were there, I’m sure the payment process would also be easier but I decided I shouldn’t fight the raw numbers on such a big purchase.
So what would you suggest people do if they want to pay down their mortgage more quickly? Just send in whatever amount they have left at the end of the month?
There are many ways, but if you are set in paying it off (as opposed to paying what you need to and investing the rest), you should put money in there as soon as you have them, as you are accumulating interest on a daily basis. What I mean is, pay a portion the day your paycheck comes, instead of once a month. People are often surprised that this little trick will save them a ton of interest, but it works for the loans that don’t have a prepayment penalty.
I always find it hard to explain a mortgage to everyone. Then when I show them the amortization schedule, it’s much easier for them to see for themselves. Good reminder to periodically check this out whenever we need to make a change.