Mortgage terms explained: What is amortization?

Today’s real estate purchaser looks very different than two or three decades ago. Old-school real estate investors focused on their business in a hands-on way, striving to fully understand everything involved. Typically, Baby Boomers who bought property also were educated on how a mortgage worked. More recently, comprehension around some mortgage terminology isn’t very well understood by home buyers, and it’s even true for investors. 

One of those terms is loan amortization. It’s a component of every mortgage but what it means and how it works aren’t always understood. If you’d like to know more about what amortization refers to, read on. 

What does amortization mean?

At its core, amortization is the process of spreading out payments on a loan balance over a set period of time. When you make a monthly payment on your mortgage, the total payment is divided into two parts: principal payment and interest. Amortizing the loan essentially schedules when the current term is over and how much principal balance remains at maturity, but plots out the loan payments as if the loan continued until it was paid in full. 

In simpler terms, amortization calculates your loan into equal monthly payments with a target end date that combines your principal and interest payment into one convenient amount. 

How amortization schedules work

After every payment you make, the outstanding balance for the loan principal changes. But since it’s terribly inconvenient to make varying payment amounts every month, a loan is amortized to combine interest with the payment on the principal loan amount.

Typically, mortgages are amortized over 15 to 30 years. An amortization schedule predetermines how much interest and principal must be paid on each payment until the mortgage loan is completely paid off. The interest amount diminishes with every payment, and more of the payment amount goes toward the principal. 

What about ARMs?

Most real estate loans are Adjustable Rate Mortages, or ARMs, that are typically expressed as 10/1, 7/1, 5/1, or something like it. What it means is that it’s at a fixed rate for the first number of years, then the interest adjusts annually for the remainder of the loan term.

While the mortgage interest rate varies every year after the fixed rate is over, it’s usually capped according to the terms and conditions on your mortgage. And if you’re like most Americans, you’ll upgrade, refinance, or take out a new mortgage before paying off the mortgage in full, restarting with a fixed rate term once again.  

Why is amortization important to know?

If your real estate purchase is a business investment, an amortization schedule reveals and forecasts your expenses in advance so you can better control your balance sheet. It’s recorded as a tangible asset and its value is written down. 

If it’s a personal real estate purchase such as for your primary residence, an understanding of amortization can help you plan your finances better. With a consistent payment coming from your account every month, it’s easier to determine how much money you have left after the mortgage payment is made. 

Why choose MBANC

If you’re a budding real estate investor, you have a large portfolio of properties, or you need funding for a mortgage with non-traditional income such as freelancing or self-employment, MBANC is a great choice. Our lending team ensures you understand everything you should know, from mortgage amortization schedules to ARMs and more, so you feel at ease signing on the dotted line. Contact us today to see how we can help you borrow better.