The amortization schedule of a mortgage loan shows how the loan will be paid off with a principal amount from each monthly mortgage payment. However, it is the interest rate and monthly interest charge that control the rate of loan balance amortization. A couple of quick calculations will show you how your payment is divided between interest and principal.
With a fixed-rate mortgage, a payment is calculated based on the loan amount, interest rate and term so that the loan will be completely paid off at the end of the payment period, typically 15 or 30 years. With each payment, a portion goes to pay interest on the loan, and a portion is principal repayment. The interest rate for a mortgage is an annual charge based on the outstanding loan balance. In the early years, when the balance is high, you pay a lot of interest. As remaining principal amount falls, you pay less interest and more principal.
Monthly Interest Calculation
Mortgage interest payments are determined monthly. The annual rate divided by 12 provides a monthly interest rate, and that percentage is applied to the current loan balance. For example, you have a 6 percent mortgage with a principal balance of $150,000. One-twelfth of 6 percent is 0.5 percent, so the interest for the next month will be $150,000 times 0.5 percent or $750. If the monthly loan payment is $1,250, the other $500 goes to pay down principal, and for the next month, the interest charge is calculated on a balance of $149,500.
Paying Down Principal
The payment portion remaining after the interest is determined will be the principal amount that amortizes the loan. Each month, the interest is based on a smaller balance than the previous month, so the interest will be slightly smaller, and the principal repayment a little bit higher. Starting with the original loan amount and calculating the interest and then principal for each payment creates the amortization schedule for the loan. The interest amount determines how much is left to provide principal amortization.
Accelerating the Amortization
The fact that the monthly mortgage interest is based on the current loan balance allows you to speed up the pay-down of your loan with extra principal payments. If you send extra money with your house payment, the additional amount reduces the balance; as a result, the interest calculated for the next month will be less than the originally calculated amortization amount. The lower interest means more principal repayment, and this change affects every payment for the rest of the loan term. In this way, adding extra principal payments allows you to pay off the home early.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.