What is a Mortgage Amortization Schedule?

Article Summary: What is mortgage amortization and what does it mean to a home buyer / homeowner? This is actually an important topic that confuses a lot of people (including myself). So I asked Melissa, our resident mortgage guru, to explain what amortization is and why home buyers should understand it.

Let's start with a quick definition. Amortization is defined as the paydown of a liability, such as a mortgage loan, in regular monthly payments over a specified period of time. The monthly payments are divided between the principal and interest of the loan.

As a part of the mortgage loan process, your lender will provide you with an amortization schedule that shows you the breakdown of your monthly payments -- how much goes to pay the interest, and how much will pay down the principal and the remaining balance until the loan is paid off. This schedule can be provided in a monthly or annual format.

As a home buyer, there are some things you need to understand about the amortization calculation or schedule you are given:

What to Know About Your Amortization Schedule

First, you want to make sure the lender has not sold you a negative amortization loan. This means that your monthly payment does not cover both principal and interest, so there would be a remaining balance at the end of your mortgage loan term. If the payment is not enough to cover the full amount of interest due as well as the principal for each month, the remaining unpaid interest amount would be added on to the balance of the loan, again resulting in a balance at the end of your loan term.

This was a common practice during the recent real estate boom of the 1990s, because many borrowers were initially unable to qualify for or afford the full payment amount on the size of loan they wanted. So the mortgage loans were structured to adjust that payment amount at a later date. This could present a real problem to a borrower if the negative amortization schedule was not fully disclosed, because at some point the loan payment is going to adjust in order to "correct" itself -- and this could mean a significant increase in the size of the payment.

You also want to make sure the term (or length) of the mortgage loan coincides with the amortization schedule you are given. For example, your loan payment is calculated or amortized over a 30 year term, but your lender has put you into a 7-year mortgage product. What this means to you is that, at the end of the 7-year loan term, the full remaining balance would be due! This is commonly referred to as a balloon loan. The previous scenario comes into play again in this situation. It spreads the payments out over a longer term, thereby making them more affordable, with the hopes that the homeowner will sell or refinance before those seven years are up.

No doubt, this can be a confusing subject. That's why it helps to have a visual aid (the mortgage amortization schedule / table) as well as someone who can explain it to you. At the same time, it's critical that you do understand this concept, so that you don't face any unpleasant surprises several years into the life of your loan.

Related blog posts:

• How much can I afford to borrow?
  
• How to apply for a home loan