What is amortization in real estate?

Buying a new home is one of life’s most thrilling and exciting experiences. For first-time homebuyers, it’s a quintessential rite of passage that signals the beginning of a brand new phase of life. And even if you’ve been through the process before, it still represents a fresh start. 

But before you turn the key on your new home, you’ll need to secure funding. For most people, this means taking out a mortgage loan. And if you’ve already started scoping out your options to find the mortgage that’s best for you, you’ve probably started thinking about amortization.

But what is amortization in real estate? What effect does loan amortization have on your mortgage and interest payment? Does it affect the amount of time it takes to pay off the loan? These are all common questions among people during the home buying process. Keep reading for the answers to those and other loan amortization questions. 

What is amortization?

Essentially, amortization describes the process of paying off a debt or loan balance in equal installments over a set period of time. It takes into account the principal balance and the interest rate to determine how much of each gets paid down with each installment until the loan balance is paid off in full.

In almost all cases, home mortgages are amortized. But other types of loans may also be subject to amortization, such as:

• Student loans
• Auto loans
• Personal loans

Amortization is broken down according to what’s known as an amortization schedule. This schedule is set by the lender and lays out the important terms of your repayment, such as: 

• The duration of the loan 
• The date and amount of each mortgage payment
• The exact amount of principal and interest paid with each installment

Understanding amortization in real estate 

Amortization can be intimidating to consider, so it would be a wise decision to consult a real estate agent before beginning the process. It’s a funny-sounding word that seems to imply a complicated and myopic process that leaves the average home-buyer mystified and confused. 

But the truth is, compared to other aspects of real estate, amortization is a relatively straightforward concept. 

Even so, the savviest home-buyers in Southern California turn to Berkshire Hathaway HomeServices California Properties when they’re searching for a new house. From escrow to insurance to, you guessed it, mortgage amortization, our expert real estate agents illuminate all the murky details so that you can see your way clearly to your new home.

When you’re shopping around and comparing mortgages and interest rates, understanding amortization can help you choose the loan that’s right for you. To that end, here’s everything you need to know about amortization. 

How amortization works 

Amortization works according to a precise formula that calculates the amount and number of payments that it will take over a given period of time to pay off a mortgage loan with a mortgage amortization schedule. The amortization calculation takes into account three factors when deciding amortization schedules: 

• The mortgage principal – This is the amount of money you’ve borrowed from the lender to pay for your new house. 
• The interest rate – Essentially, the interest payment is the fee that lenders charge you for lending you the money. It’s usually applied incrementally at a rate commensurate with a percentage of the principal balance. Interest rates can be fixed, meaning they never change throughout the life of the loan, or adjustable, meaning the rate may fluctuate. 
• The duration of the loan – The amount of time you need for the loan payment is the final factor your lender will consider for amortization. Typically, most home mortgages are paid off over the course of between 15 and 30 years and through a monthly mortgage payment schedule.

It’s important to know that factors like your down payment amount and money paid in closing costs are not amortized along with your mortgage when creating your loan amortization schedule. Likewise, funds for property taxes and insurance premiums are also excluded from your amortization schedule, unless you choose to include them. 

If that sounds like a lot of math, you needn’t worry: when you take out a mortgage, your lender performs the calculations that determine your amortization schedule.

That said, there’s an argument to be made for estimating your amortization payments before you pull the trigger on a mortgage. Fortunately, many lending companies feature amortization calculators on their websites, which can make the mathematics more manageable. 

On the other hand, the expert real estate agents at California Properties are an invaluable resource for answering all of your home buying questions, whether that’s amortization or anything else. 

Having an advanced sense of what your amortization schedule might look like is an effective way of estimating many of the details of your mortgage, including:

• How quickly you’ll build equity – When you start chipping away at the principal of your mortgage, you’ll begin earning equity, or ownership in the house. Because an amortization schedule shows how much principal you’ll pay off with each installment, it can help you estimate how much equity you’ll have at various stages of the loan. 
• How much you’ll pay in interest – Estimating amortization for different common loan periods, such as 15, 20, or 30 years, can help you determine how much total interest you’ll pay over the life of the loan. 
• How you can pay your mortgage off early – If your goal is to pay off a 15- or 20-year mortgage in five or 10 years, knowing the amortization can help you devise a plan for doing so. For example, you can use it to figure out how much you can save on interest by making extra payments toward your principal or what you could save by refinancing your mortgage at a lower interest rate. 

Understanding your amortization schedule 

Once your mortgage lender has calculated your amortization schedule, they’ll provide you with a copy. This is a crucial document that contains a wealth of information regarding the repayment of your mortgage, so understanding it and reviewing it closely is vital. 

Once you receive your amortization schedule, a few of the most important details you’ll want to review include: 

• The number of total payments you’ll need to make
• The date when the first payment is due
• The date of the final payment
• The amount of principal and interest each payment cover

Because the interest rate on your mortgage is a percentage of the principal balance, payments made during the early life of your loan will mostly go toward interest. But thanks to amortization, you’ll also be making strides to pay down your principal balance. This decreases the amount of interest with each payment until your final payments are almost completely going toward the principal. 

Positive amortization vs. negative amortization 

Although nearly all home mortgage loans are amortized, they aren’t all amortized in the same way. How your mortgage is amortized will depend upon your personal lending situation and your mortgage lender. 

There are two types of amortization in real estate: 

• Positive amortization – Positive amortization means that each payment covers a percentage of the interest and the principal balance so that the entire loan is paid off by the end of the term. 
• Negative amortization – Under negative amortization, payment installments aren’t enough to cover the interest on a mortgage. As a result, even though you’re making regular payments, your loan amount increases. Loans that carry negative amortization are not fully paid off by the end of the loan period.

Most mortgage lenders require positive amortization because it increases their chances of recouping more of the principal in the event of non-repayment. However, in certain cases, negative amortization is the preferred option. A knowledgeable real estate expert can point you toward a lender that can help you understand the differences between positive and negative amortization and which option is best for you.

Understanding different kinds of mortgages

It’s important to keep in mind that amortization is not the same thing as your mortgage. Your mortgage is the loan itself, while amortization merely describes your plans and responsibilities for repayment.

And while understanding amortization is one step toward finding the mortgage that’s best for you, it only takes you so far. It’s just as important that you understand the differences between the various mortgage types. Among other things, these differences can affect how your mortgage is amortized. 

A mortgage is a loan that’s used to purchase a house. It’s a type of secured loan, which is a loan that’s backed by collateral that the borrower has put up. In the case of home-buying, your home is that collateral. Should you fail to make your regular payments, your lender has the right to seize the property through a process known as foreclosure. 

The most common types of mortgages include:

• Fixed-rate mortgages – With fixed-rate mortgages, interest rates and payment amounts remain fixed, or stay the same, throughout the life of the loan. For buyers who live and breathe by budgeting and pre-planning, fixed-rate mortgages are usually the best choice. That said, changes in the price of homeowner’s insurance premiums and property taxes can still cause changes in your monthly payment amount.
• Adjustable-rate mortgages – If you choose an adjustable-rate mortgage, your interest rates and monthly payment amounts can fluctuate over the course of the loan. Typically, the interest rate is fixed for a predetermined amount of time, usually three to 10 years, after which it may go up or down in response to market conditions. Sometimes, the fluctuations on these loans can be very dramatic, though they may initially feature smaller payments and lower interest rates.
• Balloon mortgages – These mortgage types feature lower monthly payments for a specified duration, at which point a larger lump sum, known as a balloon payment, is due.

Choosing a mortgage that’s right for you

There are several factors you should consider before you decide on a mortgage type. The mortgage type that’s right for you depends upon your personal preferences, plans for the future, and individual financial situation, among other things. It is also important to understand acceleration clause in real estate because it may be the key to your house buying journey.

When weighing your mortgage options, consider aspects like:

• How long you plan to live in the home – If you’re planning on staying in your new home for a long period of time or forever, a fixed-rate mortgage likely makes more sense, as it allows you to anticipate a standard monthly payment. On the other hand, the comparatively lower interest rates of adjustable-rate mortgages are often more desirable if you’re planning on selling the house within a few years.
• Current interest rates – If you’re taking out a mortgage at a time when interest rates are high, an adjustable-rate mortgage can allow you to take advantage of lower rates in the future. But if interest rates are relatively low when you buy, it’s a good idea to lock yourself into them while you can.
• Your personal finances – Adjustable-rate mortgages can be attractive to home buyers with restricted budgets, as they offer lower initial monthly payments than fixed-rate loans, and you have the flexibility of refinancing later. But if you can afford the higher monthly payments that come with fixed-rate loans, you don’t have to worry about skyrocketing interest rates in the future. 

When choosing a mortgage, it’s also worth considering your own financial literacy and interest in learning. While the stable payment schedules and unchanging interest rates of fixed-rate mortgages are fairly easy to understand, adjustable-rate mortgages can get rather complicated by details like:

• The length of the initial fixed-rate period
• The range within which the interest rate can fluctuate
• How often the interest rate can fluctuate 

Find the home and mortgage of your dreams with Berkshire Hathaway HomeServices California Properties 

The right mortgage combined with the right amortization plan can mean the difference between a home mortgage loan that sets you up for a long future of home-owning bliss and one that makes buying a house confusing, stressful, and even unnecessarily expensive. 

Fortunately, the real estate experts at California Properties are standing by to guide you through the entire home-buying process. Our highly trained, immensely qualified real estate agents work with you to get to know you as a person and evaluate your individual needs and circumstances. 

Then, we’re with you every step of the way, from finding listings that appeal to you to helping you understand the mortgage lending process to the moment you sign the final paperwork. If you’re also wondering “what is a bridge loan?” or “what is a contingency sale” we’ve got you covered!
Are you in the market for a new house? Find out how Berkshire Hathaway can help you close the deal on your dream home. Visit one of our offices today!

Sources: US News, US News, US News