Calculating how much home you can afford can be difficult and feel overwhelming. You need to consider how much down payment your finances allow as well as the monthly payments you can realistically make before finding the right home. One term you will hear during the mortgage phase of buying a home is amortization. It’s a term that you may not be familiar with, but it is important to help you understand what will happen to your mortgage in the long term. We’ve got the details for you.
What Does Amortization Mean?
Used in the context of a home mortgage, amortization is the process of paying off debt through monthly payments of principal and interest over the term of a loan. Interest on amortized loans is paid in arrears (after the cost is incurred), and more interest is paid during the early period of the loan while more principal is paid toward the end of the loan. Although your actual monthly payments remain the same, examining an amortization schedule reveals that the ratio of interest to principal in a payment changes each time. Basically, in the beginning more of the money you pay your lender goes toward interest. As you get further into your loan term, more of your money goes to pay back what you borrowed (the principal).
What It Means for You
The key to taking advantage of amortization is determining the right payment amount — you need to decide what mortgage amount you can afford each month. Since the amount dedicated to interest and principal varies from payment to payment, you are paying more interest in the beginning of a mortgage and more principal later in the loan. This means the rate at which you gain equity in your home is much slower in the initial years of your mortgage. If you can afford to, you may want to make extra principal payments to reduce the interest due on each future payment and shorten the length of the mortgage overall.
Amortization will also become important if you ever want to refinance. It’s important to compare the amortization schedules before you decide if refinancing is worth the money. Carefully reviewing your amortization schedule before buying a home can help you determine if you will be able to meet your financial obligations and goals over the loan term. It can also be eye-opening to see the total amount of money that you will pay in interest. Keep in mind that qualifying for low mortgage rates is dependent on a number of factors, including your credit score. You can check two of your credit scores for free every month on Credit.com.
It’s best not to be afraid of the unfamiliar associated with the homebuying process. It’s important to do some research, ask questions and make sure you fully understand what you are agreeing to when you are signing for a mortgage.