Ever wonder how your mortgage goes from a pain in your neck to free and clear?
Well, it all has to do with a little thing called “amortization,” which is defined as the reduction of debt by regular payments of interest and principal sufficient to pay off a loan by maturity.
Understanding the way your mortgage amortizes is a great way to understand how different loan programs work. And an amortization calculator will show you how your balance is paid off on a monthly or yearly basis. It will also detail how much interest you’ll pay over the life of your loan, assuming you hold it to maturity.
Early Payments Go Toward Interest
(pictured above is an actual “amortization schedule” from an active mortgage about five months into a 30-year mortgage)
During the first half of a 30-year fixed-rate loan, most of the monthly payment goes to paying down interest, with very little principal actually paid off. Towards the last 15 years of the loan you will begin to pay off a greater amount of principal, until the monthly payment is largely principal, and very little interest.
This is important to note because homeowners that continuously refinance will find themselves back in the interest-paying portion of the loan every time they start anew, meaning they’ll pay a lot more interest over the years. Each time you refinance, assuming you refinance into the same type of loan, you’re essentially extending the amortization period of the mortgage. And the longer the term, the more you’ll pay in interest.
Tip: If you have already paid down your mortgage for several years, but want to refinance to take advantage of low mortgage rates, consider refinancing to a shorter-term mortgage. This is one simple way to avoid “resetting the clock.”
Let’s look at a mortgage amortization example:
Loan amount: $100,000
Interest rate: 6.5%
Monthly mortgage payment: $632.07
Say you’ve got a $100,000 loan at 6.5% on a 30-year fixed payment. The monthly principal and interest payment is $632.07. If you break down the very first monthly mortgage payment, $541.67 goes toward interest and $90.40 goes toward principal. The total debt is reduced by $90.40, so next month you’ll only owe interest on $99,909.60.
So when it comes time to make your second monthly mortgage payment, interest is calculated on the new, lower balance. The payment would be the same, but $541.18 would go toward interest and $90.89 would go to principal. This interest reduction would continue until your monthly mortgage payments were going primarily to principal.
In fact, the 360th payment in our example contributes just $3.41 to interest and a whopping $628.66 to principal.
Consider Larger Mortgage Payments to Shorten Amortization Period
Okay, so now you have a better idea of how your mortgage amortizes. Your next move will be to determine if paying your mortgage down faster is a good idea.
In the example above, you’ll pay a total of $227,545.20 over the 30-year term, with $127,545.20 going toward interest.
If you make slightly larger payments, say $700 each month instead (consistently), your mortgage term will be cut by roughly seven years (23 years total) and you’ll only pay $76,448.10 in interest. That will save you about $50,000 over the life of the loan…not bad.
How to pay off a 30-year mortgage in 15 years:
If you want to cut your mortgage term in half, simply figure out what the 15-year payment would be, then make that payment each month until the mortgage is paid in full. In general, this is about 1.5X the 30-year payment.
For example, a $350,000 mortgage set at 5% would require a monthly payment of $1878.88 in order to be paid off in 30 years. If you made the 15-year payment of $2767.78 instead, the mortgage would be paid off in 180 months, or 15 years.
How to pay off a 30-year mortgage in 10 years:
If you want to pay off the mortgage in just 10 years, the rule of thumb is to double your monthly mortgage payment. It’s not exact, but it’s very close.
Using our example from above, you’d need a monthly payment of $3712.29 to extinguish the loan in 120 months.
How to pay off a 30-year mortgage in 5 years:
If you’re really impatient and want to pay off the mortgage in five years, you basically have to make anywhere from 3.5-4X the monthly payment. That’s $6,604.93 in our example to pay it all off in 60 months.
How to pay off a 15-year mortgage in 10 years:
If you have a 15-year fixed, but want to pay it down in 10 years, you can generally make a monthly payment about 1.5X and it’ll be paid off in 120 months.
How to pay off a 15-year mortgage in 7 years:
To cut your 15-year mortgage term in half (or a bit more), doubling mortgage payments would pretty much lower the term to seven years or less, perhaps closer to 6.5 years.
How to pay off a 15-year mortgage in 5 years:
For those with a 15-year mortgage who want to triple the payoff speed, a monthly payment roughly 2.5X will get the job done.
You can do this same formula for basically any mortgage term and desired payoff duration. So if you have a certain payoff date in mind, figure out the number of months first, then plug in that monthly payment to get the length of the mortgage down.
Take the time to look into biweekly mortgage payments as well. These are mortgage payments made every two weeks, which equates to 26 total payments a year, or 13 monthly mortgage payments. That extra month payment per year goes toward principal, lowering the total amount of interest paid and decreasing the term of the loan.
Every potential homeowner should take a look at an amortization schedule or a mortgage calculator to determine exactly how mortgage payments apply in their particular situation. Simply knowing your interest rate is not enough to make an educated decision on a loan product.
Read more: 30-year vs. 15-year mortgages.