Amortization In Real Estate: A Complete Guide And Definition

As you embark on the mortgage process and obtain a home loan, you might start to hear the term “amortization” when discussing your loan repayment. In fact, Amortization is just an intimidating word to describe the process of paying off a loan in a series of installments.

We’ll be discussing what amortization is as it relates to real estate and how amortization works with different types of mortgages.

Amortization is a way to pay off debt in equal installments that include varying amounts of interest and principal payments over the life of the loan. An amortization schedule is a fixed table that shows how much of your monthly payment goes toward interest and principal each month for the full term of the loan. Let’s go over a few key amortization terms.

• Fully amortized loans: A fully amortized payment is one where, if you make every payment according to the original schedule on your term loan, your loan will be fully paid off by the end of the term.

• Positive amortization: Lenders typically require a borrower to repay part of the principal with each loan payment to reduce their repayment risk. This results in the loan balance decreasing with each payment which is called positive amortization.

• Negative amortization: This is when a borrower is making the required payments on a loan but the amount they owe continues to rise making it harder to afford because the minimum payment doesn’t cover the cost of interest.

Now that you know what amortization is, we’ll describe how amortization works with different types of mortgages.

Fixed-Rate Mortgages

A fixed-rate mortgage is a great option for those who plan to stay in their home for a while. These types of loans have a fixed interest rate throughout the duration of the loan. The amount a borrower pays may fluctuate based on local tax and insurance rates, but for budgeting purposes, fixed-rate mortgages provide a predictable monthly payment.

At the beginning of a fixed-rate mortgage, more of the monthly payment is applied to the interest. Over time, that changes and more of the monthly payment is applied to the principal as the interest balance decreases.

Adjustable-Rate Mortgages (ARMs)

Most adjustable-rate mortgages (ARMs) have an introductory period between 5 and 7 years where the borrower pays a fixed interest rate that is usually lower than the market rate. Once the introductory period is over the lender will then look at a predetermined index to determine the appropriate rate for the borrower.

If the market interest rates have increased, the borrower may see an increase. If the market rates have decreased, the borrower could see a decrease in their interest rate. ARMs have a cap for the highest and lowest interest rate your loan can incur.

Interest-Only Mortgage

Interest-only mortgages can be an appealing loan type for those who want to buy a home and keep the monthly payments low. With a 30-year interest-only loan, the borrower may only pay interest during the first introductory 10 years. After that, principal and interest payments would be made for the remaining 20 years of the loan term.

Balloon Mortgages

A balloon mortgage is any financing that includes a lump sum payment schedule at any point in the term. Balloon loans can be structured many ways. During the introductory period they can be interest-only payments, like discussed above. Many balloon mortgages include principal and interest in monthly payments, but the borrower must always be prepared to deal with the lump sum payment, usually at the end of the term of the loan.

Let’s take a look at an example of a borrower paying off a mortgage loan of $200,000.00. This table shows how much of the monthly payment is going toward interest and principal as well as what the remaining balance is after those payments. The table reflects an interest rate of 6.5% amortized at 30 years.

Understanding how amortization works can give you great insight to the mortgage type that will work best for you and your financial situation. Owning a home is one of the largest purchases most people will make, so it’s important to make the most out of this investment.

When you’re ready to start the mortgage process, apply online with Rocket Mortgage^®.