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Making sense of amortization: What every homebuyer needs to know

By: Mitch Mitchell
May 17, 2023

Picture the day when you're finally done with house hunting. You've found your dream home, made an offer, and it's been accepted. Exciting times! Now, you're getting ready to apply for a home loan.

Mortgages are a big deal and can take years to pay off. The way those mortgage payments are set up is called “amortization.” It might sound complicated, but it's actually pretty simple and can have a huge impact on your finances over the long run.

Let's dive in.


What exactly is amortization?

Amortization is commonly used when figuring out how borrowers will repay loans. And not just mortgage loans. Car loans, student loans and business loans all have different terms, but they all tend to use amortization to help borrowers understand how much they will be required to pay each month and the total amount they will pay over the life of the loan.

Simply put, amortization is the process of spreading out the repayment of a loan over time. A chunk of each payment goes towards the principal, while another chunk pays off the interest on the amount still owed. 

Initially, when you owe the entire loan amount, your interest payments will be higher than the amount applied to paying off the loan. But, as you chip away at the principal, interest costs drop and more money is used to pay down the loan. 

How does this help you, the homebuyer? If you have a fixed loan, you know that even though your payment's principal and interest positions will change, you're never making a higher payment than your very first. Payments are fixed from month to month and year to year, making it easier to plan for whatever life throws you down the road.


How does amortization work?

Initially, most of your monthly payment goes toward paying interest, and a smaller portion goes toward reducing the principal. Over time, the allocation of the payment shifts so that more goes toward paying down the principal, and less goes toward paying interest. 

Eventually, after making regular payments over the life of the loan, the loan will be fully paid off, and you'll own the property free and clear.

Making sense of amortization: What every homebuyer needs to know

How is your monthly mortgage payment determined?

With a fixed loan, monthly payments are structured so that the loan is fully repaid by the end of its term. The amount of each payment is determined by the amount borrowed, the interest rate and the loan term.

  • Loan amount: This is the total amount of money being borrowed — typically the price of the home, minus your down payment you're putting down — that you'll need to repay over time, along with interest.
  • Interest rate: This is the percentage of the loan amount you'll pay your lender for borrowing the money. Most mortgage loans have a fixed interest rate, so the interest rate will not change over the life of the loan. 
  • Loan term: This is the length of time you have to repay the loan — typically measured in years. Sometimes it's described as the number of monthly payments you'll need to make. So if you have a 30-year loan, you have 360 payments.


Here's an example of mortgage amortization applied

Once your lender uses the information above to calculate your monthly loan repayments, they can provide you with a loan amortization schedule — a detailed breakdown of how much of each payment goes toward interest and how much goes toward reducing the principal balance. 

Let's imagine that the house you're looking at is listed for $350,000 and the seller has accepted your full-price offer. If you had $50,000 saved for a down payment, you'd need to borrow $300,000. Now imagine that your lender offers to loan you that amount at a fixed rate of 6% interest to be paid back over a 30-year term.* 

In this hypothetical example, your lender would determine that to repay the loan, you'd need to make 360 payments of roughly $1,799 each. These payments would remain constant throughout the life of the loan, but the amount that goes towards paying interest and reducing the principal balance changes over time. 

  • For example, in the first month, a $1799 payment will apply $1,500 to interest and just $299 towards the principal. Then, as the months go by and your loan balance decreases, the amount that goes to pay interest would also decrease. 
  • In a year, at the 12th payment, $1,481 is directed towards interest and $318 towards the principal. 
  • By year two, the 24th payment — still $1,799 — is split $1,463 to interest and $336 to the principal. 
  • Slow and steady, you're paying off the loan amount and decreasing the applicable interest. After ten years of owning your home, $543 of your monthly payment will be applied to the principal. And by year 20, your payment has flipped. Now $988 is going towards the principal and a smaller amount, $810, is going to interest.
  • By the end of the 30-year term, your final payment of $1799 will only have $9 going to interest and the rest to pay off the loan. Now the home is yours, free and clear. Your loan balance is $0.00.

Pro Tip: We suggest getting in the sandbox and playing around. One of the best mortgage amortization calculators out there is found at Investopedia. Just input your loan amount, interest rate, loan term and repayment start date. The online tool will provide charts and diagrams to show you precisely what your amortization will look like.


Now you know!

Whether you're a first-time homebuyer or a seasoned homeowner, it's important to know how amortization works and how it applies to mortgage loans. And try out our mortgage calculator to see how amortization will roll out for you.

Remember, at the start of your mortgage, you pay more interest and less principal, so it takes longer to build equity in your home. If you can afford it, you might want to make extra payments towards the principal to reduce the interest and shorten the overall length of your mortgage. 

Connect with a Movement Mortgage loan officer in your area. They'll see how much you may qualify to borrow and look at how your monthly mortgage payments could change based on amortization and a 30-year or 15-year term.

*Interest rate information is for example purposes only. Rates may vary.

black and white photo of Mitch Mitchell
Author: Mitch Mitchell

Mitch Mitchell is a freelance contributor to Movement's marketing department. He also writes about tech, online security, the digital education community, travel, and living with dogs. He’d like to live somewhere warm.