Amortization

Mortgage loans are paid using a process called amortization. This process pays off a loan (including principal and interest) over a certain period of time. At the end of that time, the mortgage will be paid in full.

Amortization is based on an unchanging interest rate, so it is used only with fixed-rate loans. (Adjustable-rate mortgages have fluctuation interest rates, which makes amortization impossible.) When you get a fixed-rate mortgage, your lender will develop a monthly payment plan based on the amount of your original loan plus the interest that will accumulate over the life of the loan. Each time you make a monthly payment, a portion of the money will go toward paying off the interest and the principal.

Your lender will provide you with an amortization schedule, which shows you how your loan will be paid for over time. It is important to note that the way your payment is allocated to the principal and interest changes over time. When you begin making payments, most of your money will go towards paying the interest. Later in the life of the loan, more of the money will go towards paying down the principal. This is the basic precept of amortization, and it affects the time it takes to build equity as a homeowner.

The reason that lenders use amortization is so that monthly payments remain stable across the life of a loan. Borrowers with fixed-rate loans prefer the stability of having a monthly payment that never changes. The payment of interest first helps that desire become a reality; without amortization, payments would fluctuate considerably.