The word “amortization” has a dozen letters and five syllables. To us, a word with more than four syllables must have a big meaning—so big that not many people fully understand what it really means. Whether we understand it or not, amortization is a part of our lives—well, at least our financial lives—and it’s here to stay.
Amortization: Which Context?
As far as we know, amortization only has one context—financial. However, it differs slightly in meaning when referring to a loan amortization versus a mortgage amortization. Essentially, the two aren’t radically different, as both refer to a debt that must be repaid. How that debt is repaid at periodic intervals is called amortization.
If we’re talking about a loan—say, a personal loan you took out with XYZ Bank—amortization refers to the payment schedule of the debt, which consists of regular payments over a specified period of time.
You’ll have a better understanding of this amortization schedule if you open your Microsoft Excel program (assuming you have one) and click on the Office button. From there, click “New,” then select “Installed Templates.” On the right-hand side of the screen, you’ll see various options. Click on “Loan Amortization.”
The screen will show a template titled “Loan Amortization Schedule.” Below it, you’ll find a box where you can enter the requested data: loan amount, annual interest rate, loan period in years (this is the same as the term), number of payments per year, start date of the loan, and optional extra payments.
The loan amortization schedule is created with a column containing the following headings: payment number, payment date, beginning balance, scheduled payment, extra payments, total payments, principal, interest, ending balance, and cumulative interest.
If we’re talking about a mortgage, amortization refers to the payment schedule for that mortgage. For example, let’s say you want to buy a house for $160,000. Your banker lends you the money at a 5.5% interest rate for a term of 25 years. Your amortization schedule will show you the payment amount, payment frequency (weekly, bi-weekly, monthly), the decreasing balance, and the number of payments remaining. To get a clearer idea, you can use the same headings mentioned above for the loan amortization schedule.
Remember, if your mortgage’s first term is five years, the amortization table will look different when you renew it after the initial term. This is because the interest rate and the life of the mortgage will change.
When you take out a mortgage, you can request a complete amortization table from your bank. Some banks will provide it without you asking, but with others, you’ll need to make the request.
Amortization Table: That’s It?
Don’t be discouraged if your amortization table shows that your payments are going mostly toward the interest rather than the principal. This is very typical in a mortgage, so don’t worry. You’ll begin to see a slow improvement after year four or five. For example, at the beginning of our mortgage, our weekly payments were around $207. Of that, only $60 went toward the principal, and $137 went to interest. You can imagine how we felt during those first few weeks of our new mortgage. No wonder they say a mortgage is the end of life! Over time, though, we’ve grown accustomed to it, and now, in year five of our mortgage, the payment toward principal is closer to $90.
It does get better—fear not! You don’t have to view your mortgage as a killjoy. Instead, look at it as an equity builder. As we mentioned in an earlier article, when you start building equity, bankers and lenders begin to see you as an attractive risk. Once your mortgage is paid off by 50%, they’ll be eager to lend you money—provided, of course, that you’ve maintained a good credit score.
Still, your amortization schedule might give you the sinking feeling that it’s a never-ending burden. Experts say that the payments split between interest and principal don’t even out until after the first 18–21 years of the mortgage. This is one reason people choose to make double payments on their mortgages when they have extra cash. In principle, the total interest you’ll pay over the course of a mortgage—by the time you calculate everything at the end of the term—is staggering.
Amortization Calculator
There are several user-friendly amortization calculators available online. Just type “amortization” into the search box, and you’ll find a few options. Most of them offer the same features as the Excel program we mentioned earlier.
Mortgage Amortization: Good News
The good news isn’t a promise of a rose garden that comes with your new house and mortgage. Sorry.
However, the good news is that someone has finally heard consumer complaints about how complicated banking and mortgage documents are. It’s about time an initiative was undertaken to simplify the language in mortgage documents.
Congratulations to the Canadian Bankers Association for tackling this simplification task. They’ve announced that Canadian banks have committed to making residential mortgage documents easier to understand. This will help ease the minds of consumers who are already overwhelmed by the decision to buy a house and who face even more apprehension when they confront the legalese of their mortgage documents.
In fact, many borrowers have already noticed improvements in the documents they receive from their banks.
According to John Kelly, Vice President of Corporate Development at the Canada Mortgage Association, Canadian banks are being asked to:
- Draft mortgage documents in a way that is easy to understand,
- Provide reading aids to help consumers find the information they need more quickly,
- Use words familiar to the average person; if that’s not possible, define legal and technical terms clearly.
Friendly reminder: If you want to make your amortization schedule leaner, try making extra mortgage payments. When it’s time to renew, perhaps…just perhaps…it won’t feel like you’re just paying interest. Otherwise, it’s going to be a long, slow ride to paradise. And by the time you get there, your hair might have turned gray…
But—think of the upside. You’ll have sizzling equity—sizzling enough to seduce the money lenders!
