When you take out a loan for a new home or car, it can be exciting to watch your debt decrease as you make payments. However, the process of how exactly this happens can be confusing.
This is where amortization comes in. While it may sound like a complicated term, amortization is simply a structured way to pay off your debt.
Whether it's a mortgage, car loan, or even a business loan, amortization plays a crucial role in determining how much you pay each month and how long it will take to fully pay off the loan.
What Is Amortization?
Most of us don’t have thousands, or even hundreds of thousands of dollars readily available to buy a home or car. Instead of paying one large lump sum, you take out a loan and make smaller, regular payments over time.
Amortization is the process of gradually paying off your loan through scheduled payments. Each payment covers two main parts:
- Interest: The amount the lender charges you for borrowing money, typically a percentage of the loan amount.
- Principal: The actual amount you borrowed and need to repay.
The rate at which your loan balance decreases is outlined in your amortization schedule. Early in the loan term, most of your payment goes toward the interest, with a smaller portion applied to the principal.
As time passes and your loan balance decreases, more of your payment will go toward reducing the principal.
At the start of the loan, it may feel like the balance isn’t decreasing much, but as time goes on, the balance starts to drop much faster. This is a typical feature of amortization.
Why Does Amortization Matter?
Understanding how amortization works can help you make better financial decisions. Here are a few ways it can impact you:
- Comparing Loan Options: Loans with shorter amortization periods typically have higher monthly payments but cost less in interest over time. For instance, a 15-year mortgage might have higher monthly payments, but you’ll pay significantly less in interest than with a 30-year loan.
- Refinancing: If interest rates drop, refinancing your loan to a lower interest rate or shorter term can save you money over the life of the loan.
- Making Extra Payments: Paying extra toward your loan principal can reduce the interest you pay and shorten the term of your loan, saving you money. Plus, at INB, we don’t charge prepayment penalties for paying off your mortgage early.
When making extra payments, keep in mind that any additional amount you pay goes directly toward the principal, reducing the interest charged for the following month. This helps you pay off your mortgage faster and saves you money in the long run.
Understanding amortization gives you control over your finances—whether you're buying a home, refinancing a loan, or simply trying to see where your hard-earned money is going.
Got questions? Please reach out to me, or any INB mortgage lender.
Champaign:
Aaron Gallagher; NMLS # 1943805
Peoria:
Karen Cabrera (also Galesburg); NMLS # 742269
Phil Raso; NMLS # 1943805
Stacy Wolak (also Wisconsin) NMLS # 689948;
Springfield:
Natalie Dodson; NMLS # 574151
Corey Kates; NMLS # 1652367
Bill Townsend; NMLS # 815738
Deena Smith; NMLS # 662911
Todd Weir NMLS # 502389