What Does Mortgage Amortization Mean?

Loosely put, mortgage amortization is the repayment of a loan that has been given by a lender for the purpose of buying real estate. Mortgage amortization (mortgage repayment) happens as a consequence of the borrower making regular payments to the lender for an agreed term until the mortgage has been settled.

How Mortgage Amortization Works

The period of accounting for mortgage amortization is usually based upon twelve payment days per year. These payment days usually occur on the first day of each month. The mortgage account itself begins on the first day of the month that proceeds the month that the mortgage became "active". The first payment that you actually make is called an "interim interest" payment. The interim interest payment covers the period between the date of your mortgage account begins and the date that your mortgage becomes active. The payments that follow the first mortgage payment commence on the first day of the following month.

Mortgage Amortization Examples

A mortgage loan of $200,000 taken out over a 30 year period at an interest rate of 6% becomes active on 15th July. Let's say the monthly payment amount will be $1,119.12.

The borrower would pay an interim interest amount of $1,119.12 from the 15th July to 1st August. The first actual amortization payment would be made on 1st September. From the 1st of September onwards the borrower's payments are split into paying interest against the mortgage loan and repaying the loan itself. Interest payments are factored by multiplying 1/12 of the remaining mortgage balance for the last accounting period by the interest rate. Using this example, the interest a borrower would pay on 1st September would be $1,000 ($200,000 ÷ 12 x 0.06 = $1,000). The remaining $199.12 of the $1,119.12 monthly payment goes towards paying the balance of the mortgage loan, bringing it down to $199,880.88.

The amortization and interest payments carry on through each month for the agreed period of the mortgage, but the amount of the monthly payment going towards interest decreases as the amount for the payment of the actual mortgage loan increases. Consequently, on the 1st of October the interest payment will be: $199,880.88 ÷ 12 x 0.06 = $999.40. The mortgage principal would be decreased by $119.72 to make a total sum owed of $199,761.16. Thus over time the ratio between interest and loan payments changes dramatically in favor of loan settlement payments.

Late Payment Fees

Many mortgage lenders will give a "grace period" to borrowers, when repayments can be deferred slightly up to the second week of the month. Most usually though mortgage payments made after the 15th of the month usually incur a late payment fee. This late payment fee can be an amount of up to 5% of the usual monthly payment amount.

Amortization Overpayment

You may want to make an overpayment against your agreed monthly payment. This reduces the balance of the mortgage loan by the exact overpayment amount over and above what is left after the interest payment. The effect of this is compounded over time: as you reduce the loan principal your future amortization payments increase further while interest payments decrease in tandem.

Mortgage Amortization Tools

A tool that can really help you to understand your mortgage payments and the effects of overpayment is a mortgage amortization schedule. Amotization schedules can be demonstrated through the use of spreadsheet packages that contain mortgage amortization formulas that show you the results of ad-hoc "what if?" scenarios such as how overpayment affaects the relationship between interest and principal payment amounts. A simple search in a web search engine will give you many possibilities to download mortgage amortization spreadsheet templates at no cost.