Amortization is the process of reducing a debt over time, most often with a fixed time schedule of payments. A straightline amortization schedule reduces the debt with equal principal payments. A mortgage style amortization schedule reduces the debt with equal payments that include both principal and interest.
A mortgage style amortization schedule is the loan pay-off schedule usually associated with residential mortgage loans. Let's say you borrow $100,000 to buy a new house, and you decide you want to pay it off over 30 years. A mortgage style amortization schedule divides the loan into 360 equal monthly payments. Consulting a mortgage loan payoff calculator, you see that if the interest rate is 5.7 percent, each monthly payment is $580.40. The first month's payment consists of $475.00 in interest and $105.40 in principal.
A straightline amortization schedule divides the principal into an equal number of payments, then adds the interest due to each month's repayment amount. If you borrow $100,000 and repay it over 30 years, each month's principal repayment will be $100,000 divided by 360, which is $277.78 each month. Consulting a straightline amortization schedule, you find that your first payment includes $473.68 in interest.
Mortgage Style Advantages
Mortgage style amortization gives you a payment schedule that is the same every month. Also, most families have household income that rises over time. In addition to predictability, the big advantage of a loan with equal payments is the greater affordability over a straightline loan, where the payments are highest at the beginning, when most families can afford it least.
The big advantage of a straightline amortization loan is that it cuts down your interest charges substantially. Over 30 years, the mortgage style loan accumulates $108,944.40 in interest charges -- more than half your total payments. Over the same time period, on the other hand, straightline amortization has total interest costs of $85,262.50, a reduction in interest charges of $23,681.90.
Another repayment schedule offers the cost-savings of the straightline amortization loan and the affordability of a mortgage style loan with 360 equal payments. If you borrow $100,000 at 5.7 percent annual interest and repay the loan with bi-weekly equal payments of $290.20 -- half the monthly mortgage style amortiztion payment -- your total interest charges will be $86,598.74, a savings of $22,345.66 over the cost of the same loan with monthly payments. You'll also pay off the loan in 24 years and nine months, five years and three months early.
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