What does “amortization” mean and why does it matter?

Definition of ‘amortization’

Merriam-Webster defines amortization as: to pay off an obligation (such as a mortgage) gradually usually through periodic payments of principal and interest or by payments to a sinking fund (a fund set up and accumulated by usually regular deposits for paying off the principal of a debt when it fall due).

Human-speak: each time you make a scheduled payment toward a loan, the percentage of how much goes toward paying off the principal balance (the original amount of the loan you took out) versus paying against interest on the loan (basically how the lending institution stays in business).

 

How to calculate the amortization of a loan

To calculate the amortization of a mortgage loan or home equity loan, divide the loan’s annual interest rate by 12 for the monthly interest rate. Then multiply the monthly interest rate by the principal amount to find the month’s interest. By subtracting this amount from the set total payment, you can determine the payment amount. OR, you can simply use our online loan amortization calculator or get an instant rate quote on our website.

 

Why isn’t my principal payment consistent? 

In a world of instant gratification, it can be disheartening as the payee to see what feels like a paltry amount of the total loan installment initially going towards paying down overall loan balances. But take heart, it gets better! The purpose of the amortization is beneficial for both parties: the lender and the loan recipient.

In the beginning, you owe more interest because your loan balance is still high. So, most of your standard monthly payment goes to pay the interest, and only a small amount goes to towards the principal.

As the term for the life of the loan matures, the balance shifts to increasingly higher percentages of the standard payment going to paying off the principal since interest on the overall balance will be much lower.

 

Can prepayments shorten my loan?

Want to pay off your loan faster? First, make sure your lender accepts principal-only payments (hint: we do!) and that you won’t be subject to pre-payment penalties (fees for paying off a loan before the end of its designated term) (hint: we don’t!). Then, by making extra payments, you’re immediately knocking down the principal balance. With a lower balance, you’ll be paying less on interest and more of each month on the remaining principal. Depending on the size and life of your loan, prepayment can save you thousands in interest and years off of your loan. Want to see how prepayments could affect your loan? See our Mortgage Payoff calculator and play around with the numbers.

 

Want to learn more about your loan payment options?

Visit your local Standard Bank office to talk with one of our loan specialists about a home equity loan or talk with a mortgage loan originator mortgage loan details. If you are just starting out, you may want to read our Home Loan Solutions booklet that gives you a great overview of loans in general.