How Mortgage Amortization Works
- While your mortgage payment stays the same each month
- The composition changes over time as the outstanding balance falls
- Early on in the loan term most of the payment is interest
- And late in the term it’s mostly principal that you’re paying back
Ever wonder how your home loan goes from a pain in your neck to real estate free and clear?
Well, it all has to do with a magical little thing called “mortgage amortization,” which is defined as the reduction of debt by regular payments of interest and principal sufficient to pay off a loan by maturity.
In simple terms, it’s the way your mortgage payments are distributed on a monthly basis, dictating how much interest and principal will be paid off each month for the duration of the loan term.
Jump to amortization topics:
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 show you how much interest you’ll pay over the life of your loan, assuming you hold it to maturity.
Trust me, you’ll be surprised at how much of your payment goes toward interest as opposed to the principal balance. Of course, there’s not much you can do about it if you don’t buy your home in cash, or choose a shorter loan term, such as the 15-year fixed mortgage.
Unfortunately, with home prices so high and home affordability so low, most home buyers (and especially first-time home buyers) tend to go with 30-year mortgages. These are the default choice, whether we’re talking about conventional loans or FHA loans.
There’s nothing inherently wrong with that, but it does mean you’ll pay a lot of interest for a very long time. Still, if you can get a better return for your money elsewhere, or if you have higher-APR debt like credit cards, auto loans, student loans, and so forth, it can still be a great choice.
How Mortgage Payments Work: Early Payments Go Toward Interest
- This is a real amortization schedule for a 30-year fixed-rate home loan
- You’ll notice that the bulk of the monthly payment is interest
- Over time the interest portion will go down and the principal portion will rise
- Thanks to a smaller outstanding loan balance
Pictured above is an actual “amortization schedule” from an active mortgage about five months into a 30-year fixed-rate mortgage. That means it’s got another 355 months to go. Almost there!
Your mortgage lender or loan servicer may provide an amortization schedule calculator that you can use to see how your loan will be paid off, or you can use any number of free loan amortization calculators found online. It can be helpful to make decisions about your mortgage going forward.
As you can see in the table above, the principal and interest payment is $1611.64 per month. It doesn’t change because the loan is fixed, but the ratio of interest to principal does.
Early on, more than $1,000 of that $1,611.64 is going toward interest each month, with just over $500 going toward the principal balance. You want those principal payments to go up because they actually pay down your loan balance. The rest just makes your lender (and loan servicer) rich.
The good news is as you pay down your mortgage, the total amount of interest due will decrease with each payment because it’s computed based on the remaining balance, which goes down as principal is paid back.
And as that happens, the amount of principal rises because a fixed mortgage has a fixed payment too. So it’s a win win. Sadly, it doesn’t happen all that quickly.
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. Toward 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 who continuously refinance their mortgages 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 loan amortization period of the mortgage. And the longer the term, the more you’ll pay in interest. If you don’t believe me, grab a mortgage amortization calculator and you’ll see.
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, such as a 15-year or 10-year fixed mortgage.
This is one simple way to avoid “resetting the clock” and stay on track if your goal is to pay off your mortgage. Use a refinance calculator to determine the best approach when doing your loan comparison analysis.
Fully Amortized vs. Interest-Only
If you’ve come across the term “fully-amortized,” you might be wondering what it means.
Simply put, if a borrower makes regular monthly payments that will pay off the loan in full by the end of the loan term, they are considered fully-amortizing payments.
Often, you’ll hear that a mortgage is amortized over 30 years, meaning the lender expects payments for 360 months to pay off the loan by maturity.
This relates to the fact that most mortgages have 30-year terms, such as the popular 30-year fixed.
To better illustrate, let’s consider interest-only mortgage payments, which are often an option on home loans.
If your lender gives you the choice to pay just the interest portion of the mortgage payment each month, it would not be considered a fully-amortized payment.
Why? Because if you continued to make those payments each month, they wouldn’t pay off the loan.
In fact, an interest-only payment would do absolutely nothing to pay off the principal balance of the loan. It would only tackle the monthly interest expense.
If you had a loan with an outstanding balance of $300,000 and solely made interest-only payments for five years, you would still owe $300,000 after those 60 months were up.
So for a loan to be fully amortized, you need to make both a principal and interest payment each month.
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 amount set at 6.5% on a 30-year fixed mortgage. The total principal and interest payment is $632.07 per month. As noted, this amount will not change from the start date of your mortgage to the very end.
If you break down the very first monthly mortgage payment, $541.67 goes toward interest and $90.40 goes toward principal. The outstanding balance is reduced by $90.40, so next month you’ll only owe interest on a balance of $99,909.60.
When it comes time to make your second monthly mortgage payment, interest is calculated on the new, lower balance.
The payment would remain the same, but $541.18 would go toward interest and $90.89 would go to principal. This interest reduction would continue until your monthly payments were going primarily to principal.
Consider Larger Mortgage Payments to Shorten Amortization Period
- If you want to pay your loan off faster and reduce your interest expense
- You can make larger payments each month to accomplish both those things
- The excess amount will go toward the outstanding loan balance
- Reducing the amount of interest due on subsequent payments
Okay, so now you have a better idea of how your mortgage amortizes or gets paid off. 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. Ouch!
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.
If saving money is your goal, you can also make an extra payment here and there if you so choose, which can make a major dent in your loan balance. It’s actually pretty incredible how far a little extra goes in the mortgage world.
Conversely, you might be happy as a clam to pay your mortgage down slowly, seeing that mortgage rates are so low relative to other types of loans and/or investment options.
For example, if you can pay a rate of 4% on your home loan for 30 years and get a double-digit return in the stock market, what’s the rush? This is why some home buyers opt for adjustable-rate mortgages with no intention of ever paying off their loans, knowing they can do better elsewhere.
How Do I Pay Off My Mortgage in 10 Years?
- If you want to pay off your home loan faster
- Say in 10-15 years as opposed to 30
- You simply need to figure out what the monthly payment would be
- Based on the number of months in which you want it paid off
Now let’s look at some specific ways to greatly speed up the loan amortization process, assuming you don’t have other credit card debt, auto loans, personal loans, and the like. I’m providing ballpark estimates here, so do your diligence with a mortgage calculator to determine what works for your particular loan amount and mortgage rate. Results may vary.
How to pay off your 30-year mortgage in 20 years:
Depending on your mortgage rate, a monthly payment of around 1.2X to maybe 1.3X should whittle your loan term down from 360 months to around 240 months, and save a ton of interest in the process.
Just find out what the 20-year payment would be and you could make 240 monthly payments instead of 360. Then plug it into a mortgage payoff calculator to see the savings.
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. Those with relatively small loan amounts might have no trouble doing this.
At the same time, it might be a big ask for someone with a jumbo mortgage who is struggling with affordability as it is.
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 instead of 180.
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 into a loan calculator to get the length of the mortgage down.
I should mention that mortgage rates are lower on shorter-duration home loans, so you may actually save more money by choosing a shorter loan term to begin with. However, you do get the added bonus of flexibility if you have a longer-term mortgage and making extra principal payments is simply voluntary.
This is why a mortgage refinance from a 30-year mortgage to a 15-year fixed mortgage can be so powerful. Not only is the term shorter, but the interest rate is lower too. Sure, the payment amount will rise, but you’ll own your home a lot sooner and pay way less interest.
Take the time to learn about biweekly mortgage payments as well if you’re into saving money. These are payments made every two weeks, which equates to 26 total payments a year, or 13 monthly mortgage payments. That extra payment each year goes toward principal, lowering the total amount of interest paid and decreasing the term of the loan.
Every prospective homeowner should also take a look at an amortization schedule and/or a mortgage calculator to determine exactly how payments apply in their particular situation. Simply knowing your interest rate is not enough to make an educated decision on a loan product, let alone buying real estate.
You’ll see how much impact even an eighth of a percentage point can make, which illustrates the importance of having an excellent credit score so you can obtain the lowest interest rate possible.
Read more: 30-year vs. 15-year mortgages.