Amortization: The Mortgage Professor #5

Summary

In this video, Jack Guton, a mortgage expert, explains the basics of mortgage amortization and how borrowers can accelerate their loan payoff. He discusses how a typical mortgage payment is split between interest and principal, with the interest portion decreasing over time. Jack emphasizes the power of making extra payments, even small ones, to significantly reduce the loan balance and save on interest. By increasing monthly payments, borrowers can pay off their loan years earlier and earn a guaranteed return equal to their loan's interest rate. It's a valuable strategy for anyone looking to save money in the long run.

Takeaways

• 😀 Understanding amortization is essential for mortgage borrowers to make informed financial decisions.
• 😀 Most mortgages today have fully amortizing payments, which pay off the loan balance over time.
• 😀 A fully amortizing payment is split into two parts: interest and principal. The interest is based on the loan's interest rate and balance, while the principal reduces the loan balance.
• 😀 As the loan balance decreases, the interest portion of each payment decreases, and the principal portion increases.
• 😀 For example, with a $100,000 loan at 4% for 30 years, the fully amortizing monthly payment is $477.42.
• 😀 In the first month, the interest portion is $333.33, and the principal payment is $144.09, which reduces the loan balance to $99,855.91.
• 😀 Over time, as the loan balance decreases, the interest portion of the monthly payment decreases, and the principal portion increases.
• 😀 Paying extra toward your loan each month can speed up the process of paying off the mortgage and reduce total interest costs.
• 😀 Even small extra payments, like $10 a month, can help pay off a loan earlier. For example, a $10 extra monthly payment could shorten the loan term by 13 months.
• 😀 Increasing monthly payments by $100 can help pay off the loan 101 months earlier, which is nearly 9 years.
• 😀 Extra payments can be viewed as investments that provide a guaranteed return equal to your loan's interest rate, which often outperforms alternative investment yields.

Q & A

What is amortization in the context of mortgages?

Amortization refers to the process where a mortgage is gradually paid off through regular, fixed payments. Each payment consists of two parts: the interest owed to the lender and the principal portion that reduces the loan balance.

How is the interest portion of a mortgage payment calculated?

The interest portion of your mortgage payment is calculated by multiplying the remaining loan balance by the interest rate and dividing by the number of months in the year. This amount is paid first, with the remaining payment applied to the principal.

What happens to the interest and principal portions of the payment over time?

At the beginning of the loan, the majority of the payment goes toward interest, with only a small portion going toward the principal. As the loan balance decreases over time, the interest portion of each payment decreases, and the principal portion increases.

How does making extra payments affect my mortgage?

Making extra payments directly reduces the loan's principal, which leads to a faster payoff and less interest paid over time. Even small additional payments can significantly reduce the length of the loan.

What is the impact of adding just $10 extra to my mortgage payment each month?

Adding $10 extra per month could reduce the loan term by 13 months, helping you pay off the loan faster and saving you money on interest.

How much would I save if I added $100 extra to my monthly mortgage payment?

By adding $100 extra each month, you could pay off your loan 101 months early, which is almost 9 years, and save significantly on interest.

Why is making extra payments a good idea for most borrowers?

Making extra payments reduces the principal, lowering the amount of interest you pay over time. This can lead to substantial savings and a shorter loan term, making it an effective financial strategy.

How does the interest rate on my mortgage relate to making extra payments?

The interest rate on your mortgage directly affects the return you get from making extra payments. Extra payments reduce the principal, and the savings from reduced interest are essentially a guaranteed return equal to your loan's interest rate.

Can making extra payments outperform other investments?

Yes, the interest savings from making extra payments on your mortgage can often outperform the yield on alternative investments, particularly when interest rates are high.

What is the bottom line of the advice given in the video?

The bottom line is simple: paying extra now can save you more later by reducing your loan balance and the interest you pay over time. It's a straightforward strategy to pay off your mortgage faster and save money.