What Is Amortization

The schedule of payments that cover the repayment of interest as well as the principal owed on the loan is called amortization schedule. Amortization is the repayment of the principal of the loan amount as well as the interest due on the loan.

Scheduled mortgage payment is payment that the borrower is required to make under the contract of the mortgage loan. The scheduled payment plus the interest equals amortization. The loan balance declines for the amount of the amortization plus the amount of any extra payment. If such payment is less than the interest the balance rises which is called negative amortization.

The Fully Amortizing Payment

The monthly mortgage payment that will completely pay off the mortgage at the end of the term is called the fully amortizing payment. On a fixed-rate mortgage the fully amortizing payment is calculated right at the beginning of the loan and this amount does not change over the entire life of the loan. For example an FRM taken of $400,000 at 6% to eight years will have a fully amortized payment of $599.56 every month. If the borrower continues to experiment everyone particularly the balance owed on the market will be completely paid off at the end of the 360th month.

On an ARM, adjustable-rate mortgage, the fully amortizing payment keeps shifting because the interest rate being charged is tied to a variable index rate. If this rate remains the same the fully amortizing payment on the market also remains the same. However when this rate changes the fully amortizing payment also changes. For example and ARM taken out for $100,000 at 6% for 30 years would have a fully amortizing payment of $599.55 in the beginning. If the rate rose to 7% after five years the fully amortized payment would jump to $657.69.

Amortization Calculation on Standard Loans

Except for simple interest loans the accounting for amortized home loans takes into consideration only 12 days in a year which consist of the first day of each month. The account begins on the first day of the month following the date the loan closes. The borrower pays interest for the period between the closing date and the date the record begins. The first payment due on the first day of the month after that.

For example, if a 6% 30 year $100,000 loan closes on March 15 borrower pays interest at the closing of the. March 15 to April 1 and the first payment of $599.56 is due on first may.

The payment is allocated between interest and principle which is a reduction in the loan balance. The interest payment is calculated by multiplying 1/12 of the interest rate times the loan balance in the previous month. For example, 1/12th of 0.06 is .005. The interest due on May 1  is .005 times $100,000 or $500. The remaining $99.56 is the principle that reduces the balance to $99,900.44.

This process repeats itself every month but the portion that is allocated to the interest gradually decreases whereas the balance that goes towards paying off the principal owner of the home mortgage rate increases.

All the payment is usually due on the first day of each month and the lenders usually gives a grace period Of 15 days to the borrower. The payment receipt of the 15 state is treated exactly as the payment would have been treated had been received on the first day of the month. Any payment received  after the 15th however is charged with a late fee of 4% to 5% of the payment amount.

Amortization Schedule

It is highly recommended that people who are undertaking a home loan should make a amortization schedule and tables for themselves. In many circumstances the borrower will be presented with an amortization schedule from the mortgage company itself but you can undertake this exercise yourself to get a good understanding of your loan. Amortization schedules that are prepared by the lenders will also show tax and insurance payment if made by the lenders as well as the balance of the tax and insurance escrow amount..

Payment rigidity

The the payment requirements for of fully amortized mortgage payments are rigid. You need to make the payments on your mortgage every month. If you happened to skip a payment in any particular month you will have to make two payments the next month and also suffer a late payment to report on your credit file. You will also make payment on the penalty charges for late payment which is typically 4 to 5% of the payment amount. If you miss payments on two successive months you will need to make three payments in the third month and might risk having your account recorded as late or delinquent to the credit bureau. Usually an account is reported as late to the credit bureau by the lender when it is more than 60 days late and reported as delinquent when it is more than 180 days late.

Falling behind on your mortgage payments is a slippery slope and missing one or two payments can make it that much harder to get back on schedule.

Amortization on a Simple Interest Mortgage

Simple interest mortgage interest is calculated on a daily payment basis rather than monthly as on a standard mortgage.

For example using a rate of 7.25% and a balance of $100,000 on both the standard mortgage would have an interest payment in month one of .0725 times $100,000 divided by 12 or $604.17. On a simple interest mortgage the interest payment per day would be .0725 times $100,000 divided by 365 or $19.86. Over 30 days this would amount to $589.89 . For 31 days it would amount to $615.75. The person who makes the payment on the first of every month will not feel any difference between these two different can of mortgages. But a buyer who takes advantage of the grace period afforded by the mortgage lender and pays on the 10th or 15th day of the month will be better off with the standard mortgage as they will get the first 10 to 15 days of the month interest free whereas the interest will accumulate on these days for a simple interest mortgage.

Also borrowers who make extra payments towards the principle of the mortgage will do better with the standard mortgage. For example if they make an extra payment of $1000 on the 15th of the month they pay 15 days of interest on $1000 on the simple interest mortgage which they would save on standard mortgage.

Borrowers who make the payment early on their mortgage will do better with a simple interest mortgage since they will save the interest by paying early. If a borrower makes the payment 10 days before it is you he will receive immediate credit with a simple interest mortgage and save interest of the portion of the payment that goes to the principal reduction for 10 days. With a standard mortgage payment received 10 days before or 10 days later within the grace period of the due date is treated and credited on the due date itself.

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