Amortization

The gradual elimination of a liability, such as a mortgage, in regular payments over a specified
period of time. Such payments must be sufficient to cover both principal and interest.

2. Writing off an intangible asset investment over the projected life of the assets.

The process of paying off a loan through specifically structured periodic payments is known as
amortization. Amortized loans are different from other loans due to the way the amount and the
structure of each payment is determined.

Mortgage payments are a common form of amortized loans, and interestingly enough, both the
term mortgage and the term amortization find their meaning in the same root word "mort." This
term means to deaden or kill, as in to "kill off" or eliminate the loan a bit at a time, via regular
payments.

Regarding home loans, payments are usually the same amount each month with a fixed interest
rate. In some cases, the last payment may be a bit more or a bit less than payments made
throughout the life of the loan.

To learn if you can afford the payments on the home of your dreams, visit a real estate
company, investment firm, or mortgage lender's website. Several offer simple to use
amortization calculators.

Amortized payments are calculated by dividing the principal - the balance of the amount loaned
after down payment - by the number of months allotted for repayment. Next, interest is added.
Interest is calculated at the current rate according to the length of the loan, usually 15, 20, or 30
years. Each payment eliminates a percentage of the interest first, and then a portion of the
principal.

MORTGAGE TERMINOLOGY
In real estate, a mortgage is a loan from a lender that is paid off with an interest rate over a
period of time. Some of the most commonly used terminology for mortgages is discussed
below.
Amortization is process of paying off a mortgage over time through regular payments.
A amortization schedule is a table or chart showing each payment on an amortizing loan,
including how much of each payment is interest and the amount going towards the principal
balance. They are also commonly referred to as amortization charts.
The principal is the amount of money borrowed in the mortgage loan. The interest rate (or
annual interest rate) is used to determine how much money is paid back to the lender in each
payment period. The term is the length of a loan usually measured in years or months.

A fixed rate mortgage is where the interest rate remains the same throughout the entire term.
The opposite of a fixed rate mortgage is an adjustable rate mortgage (ARM). This is where
the interest rate may be adjusted over the duration of the loan. The length of time between
each rate change is called the adjustment period. So a 5-year ARM indicates that the interest
rate of the loan can change after 5 years. For more information, visit the Federal Reserve's
Handbook on Adjustable-Rate Mortgages.
The annual percentage rate is the regular interest rate plus any additional financial charges,
such as closing costs or other fees, that are expressed as part of the total interest rate.
A scheduled payment is the amount of money the person must pay back to the lender each
month, year, or other time interval. The payment often includes a portion that goes towards
interest while the rest is used to pay off the remaining balance of the mortgage loan.
Default occurs when a debtor is unable to pay back a loan either from missing scheduled
payments or violating a condition of the loan. For information on avoid default and
foreclosures, read the Federal Trade Commission's article entitled 'Mortgage Payments
Sending You Reeling?'.
WHAT IS AMORTIZATION?
Amortization is process of paying off a debt (often from a loan or mortgage) over time
through regular payments. A portion of each payment is for interest while the remaining
amount is applied towards the principal balance. The percentage of interest versus principal in
each payment is determined in an amortization schedule.
Amortization terminology is also fairly standard. The most commonly used words include
principal, interest rate, and term.
The principal is the amount of money borrowed in the loan. If you get a loan for $250,000,
the principal of the loan is $250,000. As you pay off the loan, the principal balance
decreases. After 20 years, the principal balance (often just referred to as the balance) may be
$135,000 for example.
The interest rate (or annual interest rate) is used to determine how much money is paid back
to the lender in each payment period. In traditional loans, a calculation is performed with the
remaining balance to determine how much of the payment goes toward interest.
The term is the length of a loan or mortgage usually measured in years or months. It is
important to note that the term length does not always indicate the number of payments
involved in the loan. A 15-year mortgage often will have 180 monthly payments (15 years x
12 months = 180).

HOW IS AN AMORTIZATION SCHEDULE CALCULATED?

A amortization schedule is a table or chart showing each payment on an amortizing loan,

including how much of each payment is interest and the amount going towards the principal
balance. Thankfully, there are many freely available websites and calculators that create
amortization schedules automatically. The downside to this is people are less informed on the
mathematical calculations involved in creating the schedule. We provide the step-by-step
calculations below for a simple fixed-rate mortgage.
Let's say you are purchasing a new home for $280,000 with a $30,000 down payment. Your
bank agrees to provide you with a $250,000 mortgage at a fixed interest rate of 5% for 30
years. What is your monthly payment? How much money are you paying towards interest and
principal each month? Let's find out.

Determine the total number of payments

In this example, you have to make one payment per month for 30 years. This means you will
make 360 payments over the course of the mortgage (12 x 30 = 360).

Determining a monthly payment

If there were no interest rate, determining your monthly rate would be simple: divide the loan
amount by the number of payments ($250,000 / 360 = $694.44). Obviously the bank has to
make money so the mortgage comes with a 5% interest rate.
It is important to note the 5% is an annual interest rate. Since all the following calculations
are based on a monthly payment schedule, the annual rate needs to be converted to a monthly
rate. The monthly interest rate would be 0.416% (5% / 12 = 0.416%).
Determining the monthly payment to account for interest requires a complicated formula
shown below.
A is the monthly payment, P is the loan's initial amount, i is the monthly interest rate, and n is the
total number of payments.
Using our numbers (P = 250,000, i = 0.416%, n = 360), the formula yields a monthly payment of
$1,342.05.

Determining the total interest

We can now calculate the total cost of the loan since you will make 360 payments of $1,342.05. The
total cost is approximately $483,139 (actually $483,139.46 if you don't round the monthly payment to
two decimals). Subtracting away the original loan amount ($250,000) leaves us with the amount of
interest: approximately $233,139. So even though the interest rate is only 5%, you almost pay as
much in interest as the purchase price!

Determining the breakdown of each monthly payment

Even though the monthly payment is fixed, the amount of money paid to interest varies each month.
The remaining amount is used to pay off the loan itself. The complicated formula above ensures that
after 360 payments, the mortgage balance will be $0.
For the first payment, we already know the total amount is $1,342.05. To determine how much of that
goes toward interest, we multiply the remaining balance ($250,000) by the monthly interest rate:
250,000 x 0.416% = $1,041.67. The rest goes toward the mortgage balance ($1,342.05 - $1,041.67 =
$300.39). So after the first payment, the remaining amount on the mortgage is $249,699.61 ($250,000
- $300.39 = $249,699.61).
The second payment's breakdown is similar except the mortgage balance has decreased. So the
portion of the payment going toward interest is now slightly less: $1,040.42 ($249,699.61 * 0.416% =
$1,040.42).

This process of calculating interest based on the remaining balance continues until the mortgage is
paid off. So each month the amount of interest declines and the amount going to paying off the loan
increases. After 360 payments, the mortgage is fully paid off.

It is important to note that our calculations do not include any additional costs such as closing costs,
property taxes, or mortgage insurance.