Lending Lingo: Understanding Amortization

The home buying process is fraught with confusing terminology, especially for first-time buyers. Understanding the lingo of the mortgage lending industry is key to gaining clarity about your home loan and understanding your responsibilities as a buyer.

If your lender has offered you an “amortized loan” or discussed an “amortization schedule,” you may be scratching your head about what this truly means to your bottom line. Below are a few common questions and answers to help you navigate the road to homeownership.

What is amortization?

Although the term may sound foreign, the concept itself is relatively simple – amortization is simply the process of paying off a loan over a defined period of time through structured payments. It allows you to pay off a large sum bit by bit, at a monthly amount you know and agree to ahead of time. Mortgages are, perhaps, the most common form of amortized loan.

How is an amortized loan payment calculated?

Lenders use a mathematical formula to determine the monthly payment on an amortized loan. First, they take the principal – that is, the amount owed after the down payment – and divide it by the number of months agreed upon for repayment of the loan. Next, interest will be added, using your loan’s interest rate calculated against the term of the loan.

What does this mean for my monthly payment?

Each monthly payment you make will first reduce a portion of the interest, and then a portion of the principal loan amount. As such, in the beginning years of your loan, the vast majority of your payments will go to pay down interest. Since interest is calculated based on the remaining principal, some buyers choose to make additional payments against the principal each month, helping to eliminate the overall loan and interest balance more quickly.

If you have questions about your mortgage loan amortization, or you wish to pay more against your principal balance each month, contact your lender’s customer service representative today.

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