How Amortization Calculations Can Help You Make Sound Financial Decisions
Amortization tables, charts, schedules or spreadsheets have become very popular for those dealing in the mortgage industry today. If you are taking out a new mortgage, an amortization chart can also be very helpful. This is because the chart will show you how much interest you are paying and in which months you're paying this interest.
This can be very informative because knowing what different mortgage amortization charts look like, help you determine which mortgage is the best one for you to take.
What Does Amortization Mean?
Amortization is the paying of a loan. The way a loan is paid down from month to month is how it is amortized. For instance, you owe $10,000 one month and $9,000 the next, the loan has amortized to the tune of $1,000. If $100 interest was paid during this month, the amortization took place at a cost of $100. So quite simply, a person taking a mortgage wants to get the fastest amortization at the lowest cost.
Rate of Return vs. Rate of Amortization
There are times during the term of a mortgage when the amortization rate is slow. In a fixed rate mortgage, this time is in the first part of the mortgage. It may be typical for a mortgage payment to be $1,400 and $200 of the payment goes toward the principal and all of the rest is going toward interest.
On this mortgage, if you pay an extra $200 during this payment. You will save $1,200 in interest charges. So, because your rate of amortization is slow, you have the opportunity to get a high rate of return by paying an extra $200 which will save you $1,200. Where else, other than making mortgage payments ahead, can you gain the benefit of $1,200 by paying $200.
As the mortgage term winds down, as in the 28th year for instance, the principal part of the payment will be large and the interest part will be small. During these months, the interest may be $150 on a payment and the principal being paid may be $1,250. Here the rate of amortization is fast, but it would take $1,250 to save $150 which means the rate of return would not be so large.
Still, it's easy to see by using amortization calculations, the rate of return by making an extra principal payment on a mortgage is very good compared to most investments. This is because even during the 28th year, a higher than 10% gain would be realized in only one month by paying $1,250 to save $150.
How About the Mortgage Interest Rate Deduction
Amortization tables make it look like paying down an mortgage at an accelerated rate may be the best investment available. However, once a mortgage is paid in full, the payer loses his valuable mortgage rate interest deduction.
If a household paying off a mortgage has an effective income tax rate of 20%, paying $10,000 a year in interest, which is a viable amount in the early years of a mortgage, some of this interest comes back to them as a $2,000 income tax refund.
Still, this is a 20% rate of return, where as we have seen before, a 600% rate of return ($200 paid/$1,200 saved) in one month is realized when the payer makes an extra month's mortgage payment.
Being Mortgage Free!
On top off all of the advantages we've seen realized by making extra payments to a mortgage every month, you must also not overlook the joy it will bring you when you are mortgage free. Not only will you no longer have the monthly obligation of a mortgage payment, you'll also be the 100% owner of any equity accrued to your home when the price of real estate rises.