Amortization: The operation of paying off mortgage debt.
Amortization sets a fixed repayment schedule for paying off of debt. Part of the payment will cover interest while the remaining amount will be applied to the principal balance. The percentage of interest versus principal in each payment is established in the amortization schedule, which distinguishes between the part of the payment that covers interest and the part that covers the principal.
Example: Under the interest method of amortization, an amount of interest equal to the carrying amount of the investment times the effective interest rate is calculated for each accounting period.
The Benefits of Early Amortization
Amortization, the process of paying off a balance over time with scheduled payments, is common for home mortgage loans. Though each monthly payment looks the same, the parts change over time.
In the beginning, the interest is highest, especially with long-term loans, and the majority of each scheduled payment goes towards the interest, while only a small part covers the balance. This means that initially homeowners will see little progress made on their debt. In other words, you don’t make much progress on debt repayment during the early years. Over time, however, a homeowner will pay less interest and begin to substantially reduce the loan amount.
“Almost everyone’s goal is to pay off their mortgage faster. The shorter the amortization period, the higher your mortgage payments will be. And the quicker you pay your mortgage off, the less interest you will pay in the long term,” says mortgage expert Alisa Aragon.
“I always recommend my clients to go for a longer amortization period and use different strategies in order to pay off your mortgage faster. By doing this, it gives you the flexibility to keep your payments lower when you need it, and increase your payments and make lump sum payments when you have extra funds available.”
Aragon also recommends taking advantage of the pre-payments without penalty clause in mortgage contracts and increasing periodic mortgage payments in order to decrease the amortization period. Rather than paying monthly, she says, homeowners should choose to pay semi-monthly, bi-weekly or if is possible weekly. This reduces the amortization period and puts more money toward the principal rather than the interest.
“Many people don’t take advantage of this clause because it is generally difficult to save the extra money to make additional lump sum payments but they can certainly increase their payments up to 20 per cent. By doing this it will help you reduce your amortization period and pay more money toward principal than interest,” Aragon says.