What Is Amortization?

What Is Amortization?

Making the decision to invest in a house is probably one of the biggest and most important life decisions you’ll make. But unfortunately it’s nothing compared to the decisions you’ll need to make about money. Determining exactly how much money you can afford to spend on a house can be extremely difficult and stressful, you’ll want probably want a house that’s big enough for your family to grow but at a price that won’t plummet you into debt.

The two main issues you’ll need to consider are how much of a down payment you can realistically afford and the size of your monthly payments. You should definitely decide this before you start looking for your dream home, knowing your budget will prevent you from falling in love with a house that’s out of your price range. A big part of the home buying process is trying to keep up with your real estate agent and understand all the complex terms they use; especially when money is being discussed. One term that most people don’t quite understand is amortization. When money is involved this term is extremely important, here’s everything you should know about amortization and how it will affect your home buying process.

What Does It Mean?

In terms of your mortgage, amortization is the method through which you pay for your house. You make monthly payments to repay your debt (principal and interest) over the agreed upon term of your loan. A mortgage is an amortized loan which means that each monthly payment that you make will be identical but the amount of interest you have to pay decreases each month while the principal increases. During the first several years of your mortgage’s term you’ll be paying almost all interest and by the end of your term you’ll be paying off the principal.

How Will Amortization Affect You

It’s important that you’re smart about your mortgage and carefully determine how much you can actually afford to pay each month. If you can only afford a small monthly payment then your mortgage amount needs to reflect this. Because the amount of money devoted to interest and principal chances with each monthly payment, you’ll end up paying off your interest before the principal. What this means for you is what you won’t be gaining equity on your house as fast as you think. During the initial years you’ll be gaining almost no equity but that will change as time passes and by the end of your mortgage you’ll gain equity rather quickly.

Amortization is a really big component of the mortgage repayment process and most people either don’t know it exists or don’t bother to fully understand it. If you’re looking to refinance your mortgage then amortization is extremely important. You’ll need to compare your amortization schedule (a list of each month’s mortgage payment categorized by how much goes towards interest and principal and then the remaining unpaid principal after each month’s payment), before you decide if refinancing is a good idea. Carefully looking over your amortization schedule can be an eye opening experience, you see firsthand exactly how much interest you’re paying and how many years it’ll be before you actually start paying off the principal of your loan.

Do Your Research

As with any financial decision it’s important that you do your own research and take responsibility for understanding all the terms and requirements associated with the process. Purchasing a house is a complicated process, so don’t be afraid to ask questions and make sure you know what’s going on before you sign on the dotted line.

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