The word “amortization” has a dozen letters and five syllables. To us, a word with more than four syllables has got to have a big meaning. So big that not many people understand what it really means. Understand or not, amortization is part of our lives – well…at least our financial lives – and is here to stay.
Amortization: Which Context?
As far as we know, amortization has only one context – financial. It does, however, differ slightly in meaning if you talk about a loan amortization or a mortgage amortization. Essentially, the two are not that radically different, because both refer to a debt that has to be paid. How that debt will be repaid at periodic intervals is called the amortization.
If we’re talking about a loan – say it’s a personal loan you took out with XYZ Bank, amortization is the payment schedule of the debt and constitutes regular payments over a specified period of time.
You’ll have a better idea of this amortization schedule if you open your Microsoft Excel program (we’re assuming you have one) and clicking on the office button. When you click on the office button, you click “new” and then click on “installed templates.” On the right hand side of the screen, you get various options. Click on “loan amortization.”
The screen then gives you a template entitled “loan amortization schedule.” Underneath it, you’ll see a box where you enter the data requested: loan amount, annual interest rate, loan period in years (this is the same as term), number of payments per year, start date of loan and optional extra payments.
The loan amortization schedule is created with the use of a column with these 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, the amortization is the payment schedule of that mortgage. For instance, say you want to buy a house for $160,000.00. Your banker lends you the money at 5-1/2% interest rate for a term of 25 years. Your amortization therefore will show you the payment amount, the frequency of payments (weekly, bi-weekly, monthly), and then the decreasing balance, as well as the number of payments remaining. To get a clearer idea, you can use the same headings given above for the loan amortization schedule. Remember that if your first mortgage is say for five years, your amortization table will look different at the time of renewal; that is, after the initial term of five years is up. It will look different because the interest rate will be different, and so will the life of the mortgage.
When you take out a mortgage, you can ask your bank for a complete amortization table. Some banks will give it to you without your asking, but with some banks you need to request it.
Amortization Table: That’s It?
Don’t be discouraged if your amortization table shows that your payments are going mostly towards the interest rate rather than towards principal. In a mortgage, this is very typical, not to worry. You begin to see a slow improvement after year 4 or year 5. To give you an example: at the beginning of our mortgage, our weekly payments were something like $207.00. Of that amount, only $60.00 went towards the principal, and $137.00 went to interest. You don’t have to ask us what we felt during those first few weeks of our brand new mortgage. No wonder they said a mortgage was the end of life. We’ve grown accustomed to that, and now on year 5 of our mortgage, the payment to principal is closer to $90.00.
It gets better, though, fear not. You don’t have to consider your mortgage as a kill joy, look at it as an equity builder. And like we said in an earlier article, when you begin to build equity, bankers and lenders begin looking at you as an attractive risk. Once your mortgage is paid 50%, they’ll be throwing money at your direction, begging to be borrowed – provided of course you’ve maintained a good credit score.
Still, your amortization schedule can give you a sinking feeling of “forever” or “larger than life.” Experts say that the payments split between interest and principal do not even out until after the first 18-21 years of the mortgage. This is one reason people like to make double payments on their mortgages if they have the spare cash. In principle, the amount of interest you pay on a mortgage – by the time you calculate EVERYTHING at the end of the term – is staggering.
There are a handful of good, user-friendly amortization calculators on line. Just type “amortization” on the search box and you’ll get a few options. Most of them echo what we’ve already provided in terms of the Excel program we mentioned earlier.
Mortgage Amortization: Good News
The good news is not a promise of a rose garden that will come with your new house and mortgage. Sorry.
The good news is, finally, someone heard consumer complaints that banking and mortgage documents are way too complicated. It’s about time an initiative was undertaken to simplify the lingo of mortgage documents.
Congratulations to the Canadian Bankers Association for taking on this simplification task. They announced that Canadian banks have committed to simplify the language used in residential mortgage documents. This will soothe the feelings of consumers who are already overwhelmed by the decision to buy a house. Their apprehensions increase as they confront the legalese of their mortgage documents.
In fact, many borrowers have already observed some improvements in the documents they receive from their banks.
According to John Kelly, Vice President of Corporate Development at Canada Mortgage Association, Canadian banks are being asked to:
- draft mortgage documents in such a way that they are easily understood,
- assist readers with reading aids to help them find the information they need faster,
- use words that are familiar to the layman; if that is not possible, efforts must be made to define the legal and technical terminology.
Friendly reminder: if you want to make your amortization schedule leaner, try making extra mortgage payments. When the time comes to renew, perhaps…just perhaps…it won’t seem like you’re just paying interest. Otherwise, it’s going to be a long but slow ride to paradise. And by the time you get to paradise, your hairs have turned gray…
But – think of the upside. You’ve got sizzling equity – sizzling enough to seduce the money lenders.