Amortization schedules are important simply because they show you how each mortgage payment breaks down into its two parts, principal and interest. With this knowledge, you can adjust your payments to include future principal payments and that will save you from paying their corresponding interest payments.
This means if a particular payment is split up in such a way that requires $200 in principal and $1000 in interest be paid, you can save the $1,000 by paying the $200 before this payment is due. In making these types of adjustments, you can save tens of thousands of dollars because you will economically be shortening the term of the mortgage.
Simple Interest Vs. Compounded Interest
I have been asked about simple interest amortization schedules. They’re really isn’t too much to explain. The opposite of simple interest is compounded interest. No compounding takes place in the paying of a mortgage. So, all amortization schedules are simple interest. Let’s prove this supposition.
On a $200,000 mortgage at six percent for two years, we can see when looking at this mortgage’s amortization table, the 25th payment has a principal due of $224.42. When we look at the 26th payment we can see that the interest due is $974.68. The total amount due on the mortgage before the 25th payment is paid is $194,936.47. To borrow this amount of money for one month would cost $974.68.
How do we know this? One way is to look at the amortization table and see what the interest is on the 25th payment. Another way to find out would be to calculate this longhand. Here’s how to do that:
$194,936.47 times 6% divided by 12 equals $974.68. Take note that six percent divided by 12 gives us the interest rate for one month. You can easily see there is no compounding taking place here. Here’s what would happen if compounding took place. The amount due monthly on the same mortgage is $1,199.10. If you were to pay this amount of money each month into a savings account whose interest compounded monthly, after 28 years your investment would be $1,046,459.33.
The significance of 28 years is that it is the amount of time from the end of the loan working backward until the 25th payment is due. At the time of this payment, as we previously discussed, the amount due on the mortgage is $194,936.47. So this proves amortization schedules are simple interest.
Interest Only Amortization
Sometimes people mistakenly use the term simple interest when they are referring to interest only. With an interest only loan, no amortization takes place. For instance, $200,000 borrowed at six percent on an interest only loan would require a payment of $1,000 each month. This $1,000 would pay nothing toward the principal, so the loan would not be amortizing. In other words, at the end of any time period from one month until infinity, the amount of principal owed would always be $200,000.
Variable Rate Mortgage Amortization
Another case in mistaken identity is referring to a simple interest amortization schedule when a person wants to refer to an amortization table for fixed interest rate mortgages opposed to a variable interest rate mortgage.
To make an amortization table for a variable interest rate mortgage, you would have to know exactly what the interest rate would be at each point throughout the term of the loan. This is impossible because variable interest rate mortgages are built on the premise the mortgage rate could go up or down. Therefore, there is no such thing as a variable rate amortization table.
So a simple interest rate amortization table is the only amortization schedule available and it is a very important piece of mathematical equations. Knowing how to use it can save you a lot of money on your mortgage. Here’s one way:
Look at the principle on the payment at the halfway point of the schedule. This would be payment number 181 on a thirty-year mortgage. Here, you would look at the principle part of the payment. If you took this amount of money and added it to each monthly payment, your mortgage would be paid in half the time.