How Is Amortization Calculated On A Home Loan?

Purchasing a home for you and your family is a big moment for most people. That being said unless you can outright buy your dream property, you're most likely making a long-term financial commitment in the form of a home loan. 

Most people are only interested in the amount they'll have to pay each month and the APR associated with their loan. However, there are several other important factors that have to be taken into account - factors such as home loan amortization. Join us as we explore this part of the home loan process and learn how it affects your loan.

Amortization Explained  

When you go to a lender, usually a bank or credit union, to get a loan, you're asking them to loan you some of their funds over a period of several or more years. In return for borrowing you the money, your lender sets an interest rate that you have to pay in order to use their funds. That's how most loans work and everything stated above is common knowledge. 

What isn't common knowledge is where your hard-earned money goes. More specifically, how your payments are distributed between the interest rate and the principal. The interest rate is self-explanatory, while the principal defines how much money you've borrowed and the amount you need to return. The principal balance changes as you pay off your loan, it decreases.

Loan amortization explains how much you'll have to pay with each installment of the loan, how much of your payment is directed at the principal, and how much of it is paid towards the interest rate. 

In most cases, the lender has set the home loan up in a way that lets them collect the interest first. The first monthly payment you make will almost completely go towards covering the interest. Every next payment will decrease the amount that goes toward paying the interest and increase the amount that goes toward paying off the principal. 

Is Home Loan Amortization Restricted Information? 

No, not at all. Most lenders will provide their loan amortization charts along with other documentation when you go to negotiate a loan. This paper is called an Amortization Schedule, and it includes a complete table of payments starting with your first loan payment and ending with the last payment. 

Going over these tables will tell you everything you need to know about how much of your money is being spent to cover your principal through the duration of the loan period. One thing to remember is that different types of loans bring different challenges when it comes to establishing an accurate table of amortization. 

Fixed Interest Loan Amortization 

A fixed interest loan is a loan where your APR stays the same. It's a fixed value that doesn't change no matter what is happening with the market or the economy. We won't get into the benefits of a fixed interest rate loans as that is a subject for another time. However, we will mention that fixed interest loans are very easy to predict considering the locked APR. 

That also means that you can predict the entire table of amortization with utmost certainty. Of course, this luxury comes at a cost since fixed APR loans are generally more expensive in the long run than their variable APR counterparts. 

Adjustable, or Variable Interest Rate Loans and Amortization 

Once you introduce a variable interest rate on a home loan, things get a bit more complicated. Variable or adjustable home loans are among the more popular forms of home loans these days. The reason for this is rather simple - when you take an adjustable-rate home loan, you're getting a period of very low-interest rates for a number of years. The length of this period will vary depending on the terms of the loan and the type of loan you're looking to get. 

The important thing to understand about adjustable-rate home loans is that they bring variable monthly payments as you progress through the loan. By the time you're 2/3 through the loan, your payments might be significantly different compared to your original payments. 

Predicting an amortization table for an adjustable home loan is extremely difficult to borderline impossible. A changing interest rate that depends on the conditions of the market is a challenge to estimate 10 or 20 years in advance. Because of that, your amortization table is going to be limited to broad estimates at best. 

Can You Trust an Amortization Table? 

So far we've discussed what amortization tables are and how they work for different types of loans. Would it be fair to say that you can estimate all of the costs of a loan using this chart? Not necessarily, no. The issue with amortization tables and charts is that they don't always contain every single expense. 

Different lenders have a way of introducing hidden costs through the final paperwork. These costs don't always appear on the amortization table, thus presenting you with a nasty surprise down the road. The best way to reduce your exposure to such situations is to ask your loan agent whether there are any hidden fees involved and if so ask for an itemized list of everything you're expected to pay. 

Aside from unlisted fees and the unpredictable nature of adjustable-rate home loans, you can pretty much rely on amortization charts to create a strategy on how to service a loan. 

Other Benefits of Amortization Tables

Amortization tables serve more than one purpose. As it turns out, they are an awesome tool you can use to compared different loans from different lenders. Generally speaking, the amortization tables you get from the lender aren't always set in stone. Many lenders will gladly work with you towards finding a solution that works well for you and for them. 

The only thing to watch out for is negative amortization. This happens when your payments aren't high enough to cover the interest on the loan. Therefore, even though you're making payments, your overall debt increases every month. 

How to Calculate Home Loan Amortization? 

Calculating home loan amortization isn't difficult granted that you know exactly how much you'll have to pay each month. Of course, this applies to fixed APR loans, as we've mentioned before. You start with month 1. The goal is to calculate how much of your first month's payment goes towards the interest rate and how much goes towards the principal. Here's how to calculate that:

Total loan amount × interest rate 12= Monthly interest

Now we take the monthly interest and subtract that from the total monthly payment. What you're left with is the amount that you'll be paying towards the principal during your first month. For month 2, you'll want to apply the same equation, but this time around you'll start with whatever principal balance is left after month 1. Keep running the numbers until you reach the last month of your payment schedule. 

If you want to automate the process and get quick results, you can always use any of the numerous online amortization schedule calculators out there. Some of the better ones will allow you to be very specific with the terms of your loan, thus returning more accurate feedback. 

Fighting The Interest 

Once a person calculates their amortization schedule, they usually fall into shock when they realize that it will take them a decade or more just to pay off the interest on their new loan. This realization tends to sting and the shock that comes with it is completely justified. The next logical step would be to look for ways to combat the interest as much as possible. As it so happens, you have a few options on the table. 

Shorter Amortization Period 

The basic rule of loans is that longer amortization periods mean higher interest, while lower shorter amortization periods are more expensive to service. Finding a balance between your monthly payment and the amount of interest you're comfortable paying is key. 

Those who are looking to spend the least amount of money on covering the interest on their loan should do everything in their power to accommodate a loan with a short amortization schedule. Such loans are more expensive upfront, but you'll be spending less money in the long term. 

Premature Payments 

Another option that can save you a lot of money on a long-term loan is to pay off your loan prematurely. In other words, if your monthly payment is $500, pay $600 every month. Doing this will help you cut years off your amortization schedule, thus saving you a lot of money in eliminated interest. 

Of course, you have to check with your lender to see if they allow accelerated payments of loans. Some lenders will refuse you the right to prematurely pay off your loan, which isn't all that strange either. Banks and credit unions profit from interest alone. Deciding to shorten the payment period literally costs them money. 

Reduce Your Appetites 

By far the best way to reduce your exposure to interest is to reduce your appetites. Going for a more affordable house, or a similar house in a cheaper location could lift a significant load off of your finances. Home loans are something you definitely have to plan out to the smallest detail. It's a long-term obligation with serious ramifications. A smaller loan is a safer loan. Of course, you'll have to find a compromise between your needs, wants, and abilities. 

Shop Around 

At the end of the day, the amortization table should only be one of the factors to take into consideration when choosing a loan. That being said, using such a table can be a great way to gauge whether your lender is someone you'd want to cooperate with for the next decade or more. If you run into a bank that refuses to give you the amortization period you need, or one that is hiding numerous fees from you, it's probably better to look for funding elsewhere. 

By the time you're reading this, the home loan markets are most likely still very strict in terms of accepted applications. The effects and trauma caused by the housing crisis of 2008 still linger around in many ways. That being said, it's not that difficult to find lenders who will cooperate with you and help you find an amortization schedule that fits into your budget and your means. 

Do Your Research 

Doing research on home loans, interest rates, different forms of payment schedules and more can be overwhelming. However, doing this research is incredibly important as well. The thing you have to remember about negotiating a loan is that you're purchasing a financial product from a company whose sole interest is to maximize its profits. 

They will do everything they can to further their bottom line, and so should you. In order to do so, you'll need to get all your facts straight and become well versed in the terminology used in this business. 

You don't have to become a leading expert on loans, but you should be able to keep up with the other side during the negotiations. Of course, everyone has their limits. If you ever find yourself out of your depth, it's perfectly fine to hit pause and call in reinforcements. 

Don't Be Afraid to Ask For Help 

Buying a house or an apartment is a big deal. For most people, it's a massive financial decision that will be a part of their lives for decades to come. If you're unsure whether you're getting a good deal, or you're being taken advantage of by your lender, it's a good idea to ask for help. 

There are plenty of financial advisers out there who specialize in home loans specifically. They will be able to tell you whether you're getting all the benefits you should be getting. Sure, their services often come at a price, but paying a financial adviser's fee is nothing compared to being trapped in a nightmare home loan for a few decades. Negotiating a home loan is a process where it's definitely better to be safe rather than sorry.