Amortization is a terminology associated with mortgage loans and is used in relation to loan payment. Therefore, changes to the principal balance of a loan (mortgage loan) over a fixed period is referred to as amortization. To be an informed borrower, it’s good to differentiate between amortization and depreciation. The two are separated by the nature of financial events taking place. Depreciation simply means the loss of value of an asset over time while mortgage amortization is the reduction of the principal on a loan over a specified time and specified interest rate. There is a fixed amount that is paid monthly; a portion goes towards the loan principal and the rest to the payment of interest on the loan to the lender.
BENEFITS OF MORTGAGE AMORTIZATION
The first good point about mortgage amortization is that they offer a clear set of monthly payments to the borrower. The payments for each month are known with certainty by the borrower hence easier to track.
Borrowers are exposed to different amortization schedules that allow flexibility depending on their financial power. The flexibility of the interest rates also adds an extra benefit to the borrower- the interests can be changed at certain predefined periods or may be fixed for the life of the loan depending on the agreement.
Another benefit of mortgage amortization is that you will pay less interest over the remaining amount of the principle (loan). As the loan balance decreases, the amount of the interest that is also accruing decreases.
CONS OF MORTGAGE AMORTIZATION
To reduce your interest cost, you need to make larger down payments. This may not be possible to many borrowers because financial resources are scarce. Therefore, many people end up paying high interest and burdened by the loan for a longer period of time.
The equity build-up as the borrowers pay the loan is another factor that makes people avoid mortgage amortization. Equity is the amount of capital that the borrower gains as they pay the loan. With mortgage amortization, the equity builds up “on the back end.” This means that the initial payments first go the payment of interest and then the principal amount is cleared after the interest.
Another negative discussion is based on the principles that are established by the consumer advocates. They argue that mortgage amortization puts both large amount borrowers and small amount borrowers on the level ground i.e. whether your mortgage loan is small or large amount; you are all subjected to the monthly payment. This discourages people who want to consolidate their loans.
The introduction of formulas has simplified thanks to the mathematical wizards, computation of the interest payments and generation of an amortization schedule. You just need to punch in some numbers and print out a table. Before you start looking for an amortization calculator for a mortgage loan, you may need to learn the formula for amortization that will help you set up your calculator in any spreadsheet program such as Microsoft Excel. There are two formulas for mortgage amortization.
The first formula helps you determine your monthly payment based upon specific assumptions about the loan. Assuming that you have a conventional loan where interest is compounded monthly, let’s define some variables for the formula:
P = the amount owed on the loan principal
I = the annual interest rate expressed as a percentage
i) Calculate 1 + J and take the result to the power of minus N (-N)
ii) Less the result from 1
iii) Take the inverse of the result (1/x).
iv) Multiply the results by J followed by P.
The following formula helps create an amortization table for the life of the loan month by month. It helps determine how much principal you owe the lender at any time in the future during the lifespan of the loan.
Let’s start by defining the variables for the formula:
P = principal, amount owed.
J = monthly interest expressed in decimal form = I / (12 x 100)
M = monthly payment
H = current monthly interest = P x J
C = amount of principal paid for the given month = M- H
Q = new principal balance of your loan- after current payment
Follow these steps to calculate your amortization table:
1. Calculate H, i.e. P x J. Current monthly interest.
2. Calculate C, i.e. M - H. The amount of principal you pay down for the particular month.
3. Calculate Q, which is (P – C). The new balance of the loan.
4. Now, set P = Q. Repeat steps 1 to 3 for the following month. Repeat for all the months of the loan.