Understanding the Mortgage Amortization Schedule

In three weeks I’ll be closing on my condo, which is my first foray into real estate. I’ve been spending a significant amount of my time researching mortgages, interest rates, tax repercussions and pretty much everything that has to do with owning a house. I’ve already written about the basics of a mortgage and the recent trend of interest rates. Most recently I have been reading about the amortization schedule of mortgage payments.

Amortization Schedule

The amortization schedule is the complete schedule of all 360 monthly payments (for a 30 year mortgage) and how much of each payment goes towards principal and how much of each payment goes towards interest. The amortization schedule also shows the remaining principal balance. Understanding how to calculate your amortization schedule is critical as it allows you to really understand how dramatically extra principal payments can decrease the amount of interest paid. In the figure below I’ve laid out my potential amortization schedule with an assumed interest rate of 6%.

To make your own amortization schedule, you have to have your interest rate, monthly payment and the remaining principal value. You take your interest rate and multiply it by the remaining principal value. You take this number and divide it by 12 as you are using a yearly interest rate, the result is the interest portion of the monthly payment. Subtract the interest portion from the total monthly payment to get the principal portion. Subtract the principal portion from the remaining principal value and you begin the process over again until you have no principal remaining.

Initially, the majority of your monthly mortgage payment goes towards interest. In fact, the majority of your payment doesn’t start going towards principal until year 19! The total amount paid in interest and principal after 30 years is $488,303.12. $262,067.12 went towards interest and $226,236.00 went towards principal. If you do not make extra payments towards principal and pay according to the amortization schedule you end up paying 2.16 times the original borrowed value.

Extra Payment Per Year

One plan for making extra principal payments is to make one extra payment equal to the monthly payment at the end of each year. This is roughly the equivalent of making a half-payment every two weeks, or the biweekly method. The following figure shows the amortization schedule if an extra monthly payment is paid towards principal at the end of every year.

As you can see the mortgage is completely paid off after 297, which is just short of 25 years. In year 15 more of the monthly payment goes towards principal than interest. The total amount paid in interest and principal is $401,896.27. $208,213.87 goes towards interest and $226,236.00 goes towards principal. Adding one extra payment per year, which goes entirely towards principal, reduces the total amount paid towards the mortgage by $86,406.85. With these extra payments you end up paying 1.78 times the original borrowed value.

There are numerous services that will try to sell you on the biweekly method, which is a great idea, IF you are not being charged a fee to do so. Jonathan over at My Money Blog recently posted about the do-it-yourself biweekly payment method. In addition to saving money on interest and paying your mortgage off sooner, the biweekly payment method has an added advantage for people who are paid biweekly.

Personal Amortization Schedule Plan

I have not decided how I will try to pay off my mortgage. I am not planning on staying in my condo for much more than five years. I’m assuming I will be thinking about a family and will want to move into a house. As you can see above, I will only have paid off $15,000 of principal, which leaves me with just over $70,000 worth of equity in my condo (between $80,000 and $85,000 if I include the incentives that were deduced from the cost of the condo). I would like to have more equity built up in my condo before I move to make my next mortgage less formidable. For this reason I will try to pay off some more of the principal than just following the amortization schedule. I will determine how much extra I will be paying off once I figure out how I can max out my retirement savings and furnish my condo.