For many people, buying a home is the biggest financial investment they will ever make. Due to the high price, most people generally need a mortgage. A mortgage is a type of amortized loan in which debt is paid off in regular installments over a period. The amortization period refers to the length of time, in years, that a borrower chooses to pay off a mortgage.
Although the most popular type is the 30-year fixed rate mortgage, buyers have other options, including 15-year mortgages. The amortization period affects not only the time it will take to pay off the loan, but also the amount of interest that will be paid over the life of the mortgage. Longer amortization periods usually mean smaller monthly payments and higher total interest charges over the life of the loan.
Shorter amortization periods, on the other hand, usually result in larger monthly payments and lower total interest charges. It’s a good idea for anyone looking for a mortgage to look at the various amortization options to find the one that works best in terms of manageability and potential savings. Here, we take a look at different mortgage amortization strategies for today’s homebuyers.
Key points to remember
- Choosing the period over which you have to pay off your mortgage is a compromise between lower monthly payments and a lower overall cost.
- The maturity of a mortgage follows an amortization schedule that keeps monthly payments equal while changing the relative amount of principal versus interest on each payment.
- The longer the amortization schedule (say 30 years), the more affordable the monthly payments, but at the same time, the more interest payable to the lender over the life of the loan.
The exact amount of principal and interest that make up each payment is indicated in the mortgage amortization plan (or amortization table). In the beginning, more of each monthly payment goes towards interest. Interest on a mortgage is tax deductible. If you are in a high tax bracket, this deduction will be more valuable than for those with lower tax rates. With each subsequent payment, more and more of the payment goes to principal and less to interest, until the mortgage is paid in full and the lender files a Mortgage Satisfaction with the county office. or the Land Registry Office.
Longer amortization periods reduce monthly payment
Loans with longer amortization periods have smaller monthly payments because you have more time to pay off the loan. This is a good strategy if you want more manageable payouts. The following figure shows an abbreviated example of an amortization schedule for a $ 200,000 30-year fixed rate loan at 4.5%:
|Table 1: Mortgage amortization schedule|
|Month||Payment||Principal paid||Interest paid|
|1||$ 1,013.37||$ 263.37||$ 750.00|
|2||$ 1,013.37||$ 264.36||$ 749.01|
|3||$ 1,013.37||$ 265.35||$ 748.02|
|180 (15 years)||$ 1,013.37||$ 516.62||$ 496.75|
|240 (20 years)||$ 1,013.37||$ 646.70||$ 366.67|
|300 (25 years)||$ 1,013.37||$ 809.53||$ 203.84|
|360 (final payment)||$ 1,013.37||$ 1,009.58||$ 3.79|
Summary of the 30-year fixed rate 4.5% loan:
- Mortgage amount = $ 200,000
- Monthly payment = $ 1,013.37
- Interest amount = $ 164,813.42
- Total cost = $ 364,813.20
Shorter amortization periods save you money
If you choose a shorter amortization period, say 15 years, you will have higher monthly payments, but you will also save significantly on interest over the life of the loan and you will own your home sooner. In addition, the interest rates on short-term loans are generally lower than those on longer-term loans. It’s a good strategy if you can comfortably cope with the higher monthly payments without undue hardship.
Remember that even though the amortization period is shorter, it still consists of making 180 sequential payments. It is important to determine whether or not you can maintain this level of payment.
Figure 2 shows what the amortization schedule looks like for the same $ 200,000 loan at 4.5%, but with amortization over 15 years (again, a shortened version for simplicity):
|Table 2: Mortgage amortization schedule|
|Month||Payment||Principal paid||Interest paid|
|1||$ 1,529.99||$ 799.99||$ 750.00|
|2||$ 1,529.99||$ 782.91||$ 747.08|
|3||$ 1,529.99||$ 785.85||$ 744.14|
|60 (5 years)||$ 1,529.99||$ 976.38||$ 553.60|
|120 (10 years)||$ 1,529.99||$ 1,222.23||$ 307.75|
|180 (final payment)||$ 1,529.99||$ 1,524.27||$ 5.72|
Summary of the 15-year fixed rate 4.5% loan:
- Mortgage amount = $ 200,000
- Monthly payment = $ 1,529.99
- Interest amount = $ 75,397.58
- Total cost = $ 275,398.20
As the two examples show, the longer 30-year amortization translates to a more affordable payment of $ 1,013.37, compared to $ 1,529.99 for the 15-year loan, a difference of 516.62 $ per month. This can make a big difference for families on a tight budget or who just want to cap their monthly spending.
The two scenarios also illustrate that amortization over 15 years saves $ 89,416 in interest costs. While a borrower can comfortably afford higher monthly payments, considerable savings can be made with a shorter amortization period.
Expedited payment options
Even with a longer amortizing mortgage, it is possible to save money on interest and pay off the loan faster with accelerated amortization. This strategy involves adding additional payments to your monthly mortgage bill, which saves you tens of thousands of dollars and frees you from debt (at least in terms of the mortgage) years earlier.
Take the $ 200,000 30-year mortgage from the example above. If an additional payment of $ 100 were applied to principal each month, the loan would be paid off in full in 25 years instead of 30, and the borrower would realize a savings of $ 31,745 in interest payments. Bring that up to $ 150 more each month, and the loan would be satisfied in 23 years with a savings of $ 43,204.16. Even a single additional payment made each year can lower the interest amount and shorten the amortization, as long as the payment goes towards the principal and not the interest (make sure your lender treats the payment this way).
Naturally, you shouldn’t give up basic necessities or withdraw money from profitable investments to make additional payments. But cutting back on unnecessary expenses and spending that money on additional payments can be a good financial idea. And unlike the 15-year mortgage, it gives you the option of paying less for a few months.
Online mortgage amortization calculators can help you decide which mortgage is best for you and calculate the impact of making additional mortgage payments. Additionally, mortgage calculators can be used to determine the best interest rates available. To get started, try this calculator.
Variable rate mortgages can allow you to pay even less per month than a 30-year fixed rate mortgage, and you may be able to adjust payments in other ways that could correspond to an expected increase in your personal income. . However, monthly payments on these can increase – the frequency depends on economic indicators and how the contract is drafted – and with mortgage interest still at near historic levels, they are probably a reckless bet for most people. owners. Likewise, interest-only mortgages and other types of balloon mortgages often have low payments, but will leave you with a huge balance at the end of the loan term, also a risky bet.
The bottom line
Deciding which mortgage you can afford shouldn’t be left up to the lender alone: even in today’s lending climate with its stricter standards, you may be approved for a larger loan than you really need. If you like the idea of a shorter amortization period so that you can pay less interest and own your home sooner, but can’t afford the higher payments, consider looking for a homeowner. house in a lower price range. With a smaller mortgage, you may be able to make higher payments that come with a shorter amortization period.
Since so many factors can influence which mortgage is best for you, it’s important to assess your situation. If you’re considering a huge mortgage and you’re in a high tax bracket, for example, your mortgage deduction is likely to be better than if you have a small mortgage and you’re in a lower tax bracket. Or, if you are getting good returns from your investments, it may not make financial sense to reduce your portfolio buildup to make higher mortgage payments. The best thing to do financially is to assess your needs and circumstances and take the time to determine the best mortgage amortization strategy for you.
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Consumer Financial Protection Bureau. “Understand the loan options.” Accessed August 11, 2021.
Internal Tax Service. “Publication 936 (2020), Home Mortgage Interest Deduction.” Accessed August 11, 2021.
Financial reference. “Accelerated depreciation”. Accessed August 11, 2021.