Couple Money

Mortgages: How Amortization Works And Why It Matters

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Looking to buy a house? Learn how to keep your mortgage affordable by understanding how amortization works!

What is Amortization for Mortgages?

Are you two looking at buying a house in the near future? Chances are pretty high you'd like to keep your mortgage affordable.

One of the best ways to prepare is understand the ins and outs of the process. An essential calculation is your amortization schedule.

Amortization is a method that lenders use to allocate payments of the life of the mortgage that takes into account the principle and the interest.

For a fixed-rate mortgage, the payment amount remains constant over the life of the loan.

For mortgages, in the beginning of your loan most of the money goes towards paying interest. As the mortgages draw to a close, the payments increasingly towards the principal owed.

Notice how little of our first year's payments are going towards principle.

As an example, I'll use our own amortization schedule to show you the big difference.

As you can see in the first screenshot, only about $150 of each month's payments is going towards paying off our mortgage principle.

That's why if you're able to accelerate your mortgage payments with extra money going towards principle, you can cut years off your mortgage and save thousands of dollars by avoiding extra interest.

In the final year, you can see how the majority of the money is going towards paying down the principle.

Amortization Formula and Schedule for Mortgages

The actual formula used for calculating an amortization schedule is:

Amortization Schedule Formula

Source: Wikipedia

Let me define the variables:

If you're looking for a free financial spreadsheet to help you with creating an amortization schedule, Vertex has a helpful one.

Getting a Mortgage You Can Afford

Running the numbers is important when buying a house and having an amortization schedule can help you get a house within your budget. 

As a part of the financing, many lenders require that the home buyer obtain homeowner's insurance.

If the buyer has a down payment is less than 20%, they may also require private mortgage insurance (PMI). That's one reason why you shouldn’t look at the minimum down payment you can get away with.

You should examine and see how much you can put down on a house (and still have savings for an emergency).

Personally, we decided to go with a more conservative mortgage amount when we went looking at homes.

Our goal was to keep our housing costs (mortgage, taxes, and insurance) no higher than 25% of our monthly income to give us a buffer.

A lower mortgage meant a down payment was better for our budget. We wanted to make sure our cash flow remained positive on a month to month basis.

Your Take on Affordable Mortgage

How about you? Did you build a good size down payment? Are you accelerating your mortgage payments?

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