When taking out a loan or mortgage from a financial provider, amortization refers to both the principal and interest payments made throughout the loan repayment plan. The loan repayment plan or loan term can range from a few months to years depending on the size of the loan taken out.
The amortized loan repayment can work either on a fixed-mortgage rate or an adjustable-rate mortgage (ARM).
For a fixed mortgage rate, the monthly payment will stay the same throughout the loan term, with only the principal and interest changing each month.
During the first few years, you will mostly repay the interest on the loan. Only after a few years, you will start repaying the physical loan.
Loan amount – $100,000
Payment schedule or repayment period – 15 years
Fixed interest rate – 5.5%
Based on this example, the repayment schedule will work as follow:
$100,000 x 0.055 (5.5%) x 15 years / 100 = $817,00 installment
$100,000 x 0.055 (505%) = $5,500 interest
$5,500 / 15 = $366,66 interest per year
$366,66 / 12 = $30,55 interest per month
Do keep in mind that this calculation is based on the first month of the first year of repayment. Each following month will change, as the loan amount decreases, both principal and interest amounts will change, but the installment amount will remain the same throughout the 10 years.
Over the following 15 years, or repayment period, the interest is paid before the principal amount, but by using an installment inclusive of both, payments will run parallel to each other. Due to the nature of the loan, initially, interest will be higher than the principal amount. Gradually as you repay the loan, the principal amount will become more than the interest.
To summarize, amortization of a real estate loan refers to the process by which the principal amount of a mortgage is reduced with each payment.
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