Often times JMAC’s brokers are asked by their clients pretty basic questions. Not everyone has a background in finance, and often time the concept of “amortization” puzzles clients obtaining their first loan. It is good thing for our brokers to know how best to explain the concept to their borrowers. How does mortgage amortization work, and is paying down mortgage debt a good idea?
It is common knowledge to our brokers that fully amortizing payments are present on most mortgages and any payment is composed of the interest due to the lender and the principal subtracted from the balance. An example of the amortization process would be a $100,000 loan at an annual interest rate of 4% for 30 years; the amortizing payment would be $447.42. To determine the first month interest due to the lender, multiply $100,000 by the interest rate of .04 and divided by 12 months to get $333.33. Then subtract $333.33 from $447.42 to get a principal balance of $144.09.
To calculate the interest due the second month, subtract $100,000 from $144.09 to get an updated loan balance of $99,855.91. Take $99,855.91 and multiple that by .04 and divided by 12 to get $332.85. Finally, subtract $332.85 from $477.42 to get $144.57. This calculation can be repeated each month, as the payment allocated to interest progressively declines and the portion allotted to the principal gradually rising.
If one of JMAC’s broker’s borrowers wants to pay off their loan rapidly, they can raise their monthly payment. In the example provided above, if the monthly payment increased by only $10, the loan would be paid off 13 months earlier. If the payment increased to $100 a month, the loan could be paid off nearly 10 years earlier!
Borrowers should also be made aware that any additional amount applied towards the monthly payment (if greater than the fixed monthly payment) is automatically applied to pay down the principal. It will also depend on the lender whether or not a large payment to the principle will allow them to receive credit in the current month as opposed to the following month.