Amortization Means Equal Monthly Payments
For anyone who is not business-savvy or who has never before taken a business course, the term "amortization" may seem foreign. It's not a word that is commonly used in every-day conversation, especially for a person who does not work in the mortgage industry or have a note on their car or home. However, a brief explanation of the word "amortization" is not as complicated as it sounds.When asked, some people will say that they know what an amortized mortgage is, but when they try to explain the concept in its most basic terms, they can't. For anyone who fits into this category, here's the answer: An amortized mortgage is a property loan for a specific amount of money that must be paid off within a pre-determined timeframe, using equal monthly payments.
A Credit Card is Not an Amortized Loan
Credit card loans are not the same as amortized loans because anyone owning a credit card can add to their credit card balance due at any given time. A credit card is considered a "revolving" loan because the life of the credit card and payments made to the credit card company can continue endlessly until one party decides to close the account.
Mortgages are Usually Amortized Loans
The most common forms of amortized loans are home mortgages and car loans. Both of these loan types constitute a base amount of money (i.e. the total cost of the home or car), plus interest. And, with a fixed interest rate mortgage, the amount paid usually stays the same per month for the duration of the loan. Often, however, the very last payment is either slightly higher or slightly lower than the rest of the payments, usually due to the interest charges.
The easiest way to determine the amortized monthly payments for a home mortgage is to utilize a mortgage amortization calculator such as the one below. It is free to use and simple to understand.
The amortization calculator will ask the user to input the cost of a new home, the down payment amount, the interest rate of the (potential) loan, and the number of years that the loan will last. The most common number of years for a loan is usually between 15 and 30.
The amount of each payment for the duration of the loan is calculated by taking the principal amount of the loan and dividing it by the total number of months that make up the loan duration. For example, if a home costs $200,000 and a the buyer will put a 20 percent down payment on it, the amount used for the amortized calculation will be $160,000 plus interest. And, if it will be a 30-year loan, the number of months used for the calculation will be 360 (30 years x 12 months per year).
Interest on the Loan
Interest on an amortized mortgage is paid as a portion of each monthly payment, as opposed to Interest Only Mortgage Loans. With an interest only loan, all of the interest on the loan is paid off before any of the principal is paid.
The way the majority of amortized loans work is that the amount of the payment interest in the first several years of payments are mostly composted of interest, and a little bit of principal. Over time, the monthly payments (which always stays the same dollar wise with a fixed mortgage) become more equal in terms of the amount allocated to interest and the amount allocated to principal. Towards the end of the loan, the amount paid each month goes primarily towards the principal amount, and less toward the interest amount. Eventually, if the loan is kept for its duration - and not refinanced - all of the principal and interest will be paid and the home will be owned outright.