Loan Amortization

[cowboy]

I just wanted to throw out some questions/thoughts about loan amortization.

From what I understand about loan amortization (which is very little) this concept basically pushes most of the interest payments to the front part of the loan duration. So for the 1st 5 years of a 30 year fixed loan 90% of the loan payment is interest and 10% is principal. The opposite is true for the last 5 years of the loan.

If a person takes out a 6% 30 year fixed loan and refinances every 5 years, is this person REALLY paying 6% interest or alot more?

Why is loan amortization used? Is it a marketing ploy? Isn’t the average homeowner in a home for 5 years? Which happens to be the time frame where the interest payments dominate the payment.

[SDEngineer]

Amortization is simply the fact that you are paying down the loan principal, not the type of interest calculation used (as opposed to, for instance, an interest only loan where you only pay interest, without reducing the principal for a number of years).

The type of interest used in mortgages is typically called “simple interest” (and is also the most common form of auto loan) – you pay the interest due as it comes due, and the remaining portion of your payment goes towards reducing the principal, so that the next year, you pay less towards the interest (as theres less principal to charge interest on) and more towards the principal.

Yes, you do pay the majority of the interest during the early period of the loan, but it is really 6% whether you keep it for 5 years or 25 – it’s just that at 25 years, you’ve paid down much of the principal, so theres much less interest to charge.

For example, on a 400K loan at 6%, your monthly payments are ~2400. During the first year, because you are paying interest on nearly the full 400K, your monthly interest comes to about 2000, and you’re only paying $400 of your payment to reduce the principal (at the end of a year, you’ve only paid down about $5K in principal). But, as the principal goes down, each year less and less goes towards interest, and more goes towards the principal. By year 25, you are down to $125K in principal, and each month of your $2400 payment only about $700 is going towards interest, and $1700 towards the principal.

This math though is why it saves a LOT of interest in the long run by making extra principal payments early in the loan. If you make the principal payments early in the loan, each $1 you put towards the loan saves you around $3 over the life of the loan. Conversely, if you wait til later in the loan, your $1 towards paying down the loan doesn’t save you much more than that dollar.

[SDEngineer]

Amortization is simply the fact that you are paying down the loan principal, not the type of interest calculation used (as opposed to, for instance, an interest only loan where you only pay interest, without reducing the principal for a number of years).

The type of interest used in mortgages is typically called “simple interest” (and is also the most common form of auto loan) – you pay the interest due as it comes due, and the remaining portion of your payment goes towards reducing the principal, so that the next year, you pay less towards the interest (as theres less principal to charge interest on) and more towards the principal.

Yes, you do pay the majority of the interest during the early period of the loan, but it is really 6% whether you keep it for 5 years or 25 – it’s just that at 25 years, you’ve paid down much of the principal, so theres much less interest to charge.

For example, on a 400K loan at 6%, your monthly payments are ~2400. During the first year, because you are paying interest on nearly the full 400K, your monthly interest comes to about 2000, and you’re only paying $400 of your payment to reduce the principal (at the end of a year, you’ve only paid down about $5K in principal). But, as the principal goes down, each year less and less goes towards interest, and more goes towards the principal. By year 25, you are down to $125K in principal, and each month of your $2400 payment only about $700 is going towards interest, and $1700 towards the principal.

This math though is why it saves a LOT of interest in the long run by making extra principal payments early in the loan. If you make the principal payments early in the loan, each $1 you put towards the loan saves you around $3 over the life of the loan. Conversely, if you wait til later in the loan, your $1 towards paying down the loan doesn’t save you much more than that dollar.

[SDEngineer]

Amortization is simply the fact that you are paying down the loan principal, not the type of interest calculation used (as opposed to, for instance, an interest only loan where you only pay interest, without reducing the principal for a number of years).

The type of interest used in mortgages is typically called “simple interest” (and is also the most common form of auto loan) – you pay the interest due as it comes due, and the remaining portion of your payment goes towards reducing the principal, so that the next year, you pay less towards the interest (as theres less principal to charge interest on) and more towards the principal.

Yes, you do pay the majority of the interest during the early period of the loan, but it is really 6% whether you keep it for 5 years or 25 – it’s just that at 25 years, you’ve paid down much of the principal, so theres much less interest to charge.

For example, on a 400K loan at 6%, your monthly payments are ~2400. During the first year, because you are paying interest on nearly the full 400K, your monthly interest comes to about 2000, and you’re only paying $400 of your payment to reduce the principal (at the end of a year, you’ve only paid down about $5K in principal). But, as the principal goes down, each year less and less goes towards interest, and more goes towards the principal. By year 25, you are down to $125K in principal, and each month of your $2400 payment only about $700 is going towards interest, and $1700 towards the principal.

This math though is why it saves a LOT of interest in the long run by making extra principal payments early in the loan. If you make the principal payments early in the loan, each $1 you put towards the loan saves you around $3 over the life of the loan. Conversely, if you wait til later in the loan, your $1 towards paying down the loan doesn’t save you much more than that dollar.

[SDEngineer]

Amortization is simply the fact that you are paying down the loan principal, not the type of interest calculation used (as opposed to, for instance, an interest only loan where you only pay interest, without reducing the principal for a number of years).

The type of interest used in mortgages is typically called “simple interest” (and is also the most common form of auto loan) – you pay the interest due as it comes due, and the remaining portion of your payment goes towards reducing the principal, so that the next year, you pay less towards the interest (as theres less principal to charge interest on) and more towards the principal.

Yes, you do pay the majority of the interest during the early period of the loan, but it is really 6% whether you keep it for 5 years or 25 – it’s just that at 25 years, you’ve paid down much of the principal, so theres much less interest to charge.

For example, on a 400K loan at 6%, your monthly payments are ~2400. During the first year, because you are paying interest on nearly the full 400K, your monthly interest comes to about 2000, and you’re only paying $400 of your payment to reduce the principal (at the end of a year, you’ve only paid down about $5K in principal). But, as the principal goes down, each year less and less goes towards interest, and more goes towards the principal. By year 25, you are down to $125K in principal, and each month of your $2400 payment only about $700 is going towards interest, and $1700 towards the principal.

This math though is why it saves a LOT of interest in the long run by making extra principal payments early in the loan. If you make the principal payments early in the loan, each $1 you put towards the loan saves you around $3 over the life of the loan. Conversely, if you wait til later in the loan, your $1 towards paying down the loan doesn’t save you much more than that dollar.

[SDEngineer]

Amortization is simply the fact that you are paying down the loan principal, not the type of interest calculation used (as opposed to, for instance, an interest only loan where you only pay interest, without reducing the principal for a number of years).

The type of interest used in mortgages is typically called “simple interest” (and is also the most common form of auto loan) – you pay the interest due as it comes due, and the remaining portion of your payment goes towards reducing the principal, so that the next year, you pay less towards the interest (as theres less principal to charge interest on) and more towards the principal.

Yes, you do pay the majority of the interest during the early period of the loan, but it is really 6% whether you keep it for 5 years or 25 – it’s just that at 25 years, you’ve paid down much of the principal, so theres much less interest to charge.

For example, on a 400K loan at 6%, your monthly payments are ~2400. During the first year, because you are paying interest on nearly the full 400K, your monthly interest comes to about 2000, and you’re only paying $400 of your payment to reduce the principal (at the end of a year, you’ve only paid down about $5K in principal). But, as the principal goes down, each year less and less goes towards interest, and more goes towards the principal. By year 25, you are down to $125K in principal, and each month of your $2400 payment only about $700 is going towards interest, and $1700 towards the principal.

This math though is why it saves a LOT of interest in the long run by making extra principal payments early in the loan. If you make the principal payments early in the loan, each $1 you put towards the loan saves you around $3 over the life of the loan. Conversely, if you wait til later in the loan, your $1 towards paying down the loan doesn’t save you much more than that dollar.

[cowboy]

I think I understand why the payment is 90% interest and 10% principal the first few years. It’s because the monthly payment is held constant over the 30 years.

[cowboy]

I think I understand why the payment is 90% interest and 10% principal the first few years. It’s because the monthly payment is held constant over the 30 years.

[cowboy]

I think I understand why the payment is 90% interest and 10% principal the first few years. It’s because the monthly payment is held constant over the 30 years.

[cowboy]

I think I understand why the payment is 90% interest and 10% principal the first few years. It’s because the monthly payment is held constant over the 30 years.

[cowboy]

I think I understand why the payment is 90% interest and 10% principal the first few years. It’s because the monthly payment is held constant over the 30 years.

[ucodegen]

The statement:
Amortization is simply the fact that you are paying down the loan principal, not the type of interest calculation used (as opposed to, for instance, an interest only loan where you only pay interest, without reducing the principal for a number of years).

is correct. There are different ways of doing the calculations. One way would be to pay a fixed % of the principle each month and all interest on principle for 1 one month period. The problem with this is that payments will be highest at the beginning of the mortgage and would drop over time.

Most people’s wages increase over time (not decrease, and maybe not increase in real terms but the same inflation that kills your salary reduces the dollar value of the balance on the mortgage). The other approach, and more common (ie. standard fixed rate amortizing loan), is to calculate a constant monthly payment that would pay off the mortgage by the end of the term and cover any accrued interest on remaining balance over the life of the mortgage. The calculations to figure this out are a little more involved. I can put the formula up (though there are also mortgage calculators that do the same thing)

[ucodegen]

The statement:
Amortization is simply the fact that you are paying down the loan principal, not the type of interest calculation used (as opposed to, for instance, an interest only loan where you only pay interest, without reducing the principal for a number of years).

is correct. There are different ways of doing the calculations. One way would be to pay a fixed % of the principle each month and all interest on principle for 1 one month period. The problem with this is that payments will be highest at the beginning of the mortgage and would drop over time.

Most people’s wages increase over time (not decrease, and maybe not increase in real terms but the same inflation that kills your salary reduces the dollar value of the balance on the mortgage). The other approach, and more common (ie. standard fixed rate amortizing loan), is to calculate a constant monthly payment that would pay off the mortgage by the end of the term and cover any accrued interest on remaining balance over the life of the mortgage. The calculations to figure this out are a little more involved. I can put the formula up (though there are also mortgage calculators that do the same thing)

[ucodegen]

The statement:
Amortization is simply the fact that you are paying down the loan principal, not the type of interest calculation used (as opposed to, for instance, an interest only loan where you only pay interest, without reducing the principal for a number of years).

is correct. There are different ways of doing the calculations. One way would be to pay a fixed % of the principle each month and all interest on principle for 1 one month period. The problem with this is that payments will be highest at the beginning of the mortgage and would drop over time.

Most people’s wages increase over time (not decrease, and maybe not increase in real terms but the same inflation that kills your salary reduces the dollar value of the balance on the mortgage). The other approach, and more common (ie. standard fixed rate amortizing loan), is to calculate a constant monthly payment that would pay off the mortgage by the end of the term and cover any accrued interest on remaining balance over the life of the mortgage. The calculations to figure this out are a little more involved. I can put the formula up (though there are also mortgage calculators that do the same thing)

[ucodegen]

The statement:
Amortization is simply the fact that you are paying down the loan principal, not the type of interest calculation used (as opposed to, for instance, an interest only loan where you only pay interest, without reducing the principal for a number of years).

is correct. There are different ways of doing the calculations. One way would be to pay a fixed % of the principle each month and all interest on principle for 1 one month period. The problem with this is that payments will be highest at the beginning of the mortgage and would drop over time.

Most people’s wages increase over time (not decrease, and maybe not increase in real terms but the same inflation that kills your salary reduces the dollar value of the balance on the mortgage). The other approach, and more common (ie. standard fixed rate amortizing loan), is to calculate a constant monthly payment that would pay off the mortgage by the end of the term and cover any accrued interest on remaining balance over the life of the mortgage. The calculations to figure this out are a little more involved. I can put the formula up (though there are also mortgage calculators that do the same thing)

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