How Loan Amortization Can Affect Your Decision to Refinance

Quick Answer

An amortization calculator can help you understand how much of your monthly mortgage payment goes toward interest and how much goes toward your principal balance. It can also show you how much you might save by refinancing with a lower interest rate or a shorter-loan term and when you may be able to get rid of mortgage insurance.

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If you've ever wondered how much of your monthly mortgage payment goes toward interest and how much goes toward the loan's principal, your loan's amortization schedule explains it in simple terms.

Amortization is the process that determines the principal and interest amounts in each mortgage payment you make for the life of the loan. Typically, mortgages are extremely front-loaded with interest, which means the majority of each payment during the first several years will go toward paying interest instead of the loan's principal balance.

Let's go over how amortization works, how to use an amortization calculator and how amortization factors into decisions like applying for a mortgage, refinancing or recasting a mortgage.

What Is Amortization and How Does It Work?

Amortization describes the process of paying off a loan, particularly how and when you pay the principal and interest during the loan term. Your monthly payment remains fixed, but the allocation of your payment adjusts as you pay down your mortgage each month.

You'll always pay more in interest at the beginning of your loan term when your balance is highest. Over time, more of your payment goes toward the principal, with less and less going toward the interest.

Amortization Example:

To see how amortization works in practice, let's look at a $250,000 mortgage loan with a 30-year term and a 4% interest rate as an example. In this case, your monthly principal-and-interest payment will be $1,193.54. You can assess how much of your payment will go toward interest by dividing 4% by 12 and multiplying that number by the remaining balance.

In this example, $833.33 of your first mortgage payment will go toward interest and $360.20 (4% ÷ 12 x $250,000 = $360.20) will go toward principal. Then, with each payment, your interest portion will decrease, and your principal portion will increase. By the time you make your last payment, only $3.97 will go toward the interest, with the remaining $1,189.57 of your loan payment going towards the principal.

Visually, the amount you'll pay in interest and principal each year of the 30-year loan outlined above looks like this:

How to Use an Amortization Calculator

If you don't want to do the math yourself, you can use an amortization calculator. Start by inserting the mortgage loan amount, interest rate and term into an amortization calculator. You'll then be able to see an amortization table with some important information you can use to determine:

  • How much total interest you'll pay during your loan's term
  • How much of your payment goes toward interest versus principal each month
  • What your loan balance will be each month over the life of your loan, which can help you determine when you'll have 20% equity in your home and subsequently be eligible to get rid of mortgage insurance
  • How much interest you'll pay for different loan terms, such as a 15-year mortgage versus a 30-year mortgage
  • How much you might save by refinancing your mortgage at a lower interest rate
  • How much you could save by making extra payments to your principal balance

The Experian Mortgage Calculator can generate a loan payment schedule with an interest and principal breakdown for every monthly payment of your mortgage. Fill in the form with essential information such as home price, down payment, term and interest rate and click "Calculate."

Mortgage Calculator

The information provided is for educational purposes only and should not be construed as financial advice. Experian cannot guarantee the accuracy of the results provided. Your lender may charge other fees which have not been factored in this calculation. These results, based on the information provided by you, represent an estimate and you should consult your own financial advisor regarding your particular needs.

You'll then see a loan summary, including the loan's total costs, principal and interest and total payment amount. By clicking the "Payment Schedule" tab, you'll receive a payment schedule reflecting the amortization of a loan—the principal and interest on each payment for the loan's term.

How Can Amortization Information Help You?

Understanding mortgage amortization can help you determine a mortgage loan's total and monthly costs. Having such knowledge can help you make informed decisions about your mortgage, such as:

Eliminating Mortgage Insurance

If you're paying for mortgage insurance, you may be able to remove it once you have 20% equity in your home. An amortization schedule can help you identify when you may be able to remove mortgage insurance from your loan. Using Experian's Mortgage Calculator, scan the Total Principal Paid column for the first month the principal paid is greater than 20% of the total home price.

To see what your payment might look like without the cost of mortgage insurance, leave the Mortgage Insurance field blank when calculating your payment schedule.

Refinancing Your Mortgage

Amortization may factor into your decision to refinance your mortgage. When you refinance, your current mortgage is replaced with a new loan, resetting the clock on your mortgage payoff. That means most of your mortgage payment will again be going toward interest, even if your new loan comes with a lower interest rate.

If you can't stomach the thought of paying all that interest each month, consider refinancing into a shorter-term loan, such as a 10-, 15- or 20-year fixed mortgage. Doing so could accelerate your amortization and cause you to pay your loan off sooner.

A shorter-term mortgage carries a more aggressive amortization schedule with lower interest rates with higher monthly payments than a 30-year mortgage. But, if you can swing the monthly loan installments, you'll save more in total interest over the life of the loan.

And depending on interest rates, it may be more affordable than you think. It's worth using an amortization calculator to run the numbers with today's interest rates to see if a shorter repayment term makes sense.

Financing a Short-term Home Purchase

Amortization can also play a role in your decision-making process if you're a prospective homebuyer planning on selling your property within a few years. Amortization allocates most of every monthly payment toward the interest owed during the first several years—severely reducing the amount of home equity you'll be able to build during that time. Unless home values rise—which can be hard to predict—you may end up paying more to the lender than you'll earn from the proceeds when you sell.

Ways to Mitigate the Effects of Amortization

Whether you're refinancing or purchasing a new home, the main downside of amortization is that it takes several years before the majority of your monthly payment goes toward the loan principal. Thankfully, there are effective ways to minimize the negative effects of amortization, including:

  • Looking for a shorter-term loan: A shorter-term loan can speed up the amortization process if you can afford the higher monthly payments. With higher payments and lower interest rates, shorter-term loans build equity faster because they allow you to pay down the principal balance more rapidly.
  • Making additional mortgage payments: Increasing your monthly payment amount or making one or more extra payments each year could save you thousands of dollars in interest over a 30-year mortgage term and help you pay off your home earlier. Contact your lender or refer to your loan's terms to ensure all additional payments go toward your loan principal.
  • Recasting your loan: If you receive an inheritance or other windfall, you may have the option to recast (reamortize) the loan if they receive a lump-sum payment toward the principal. Recasting won't change your loan's interest rate or term, but it does lower your monthly payment based on your reduced principal.
  • Looking for the lowest possible interest rate: Getting a lower interest rate is one of the most common reasons to refinance. Use the Experian Mortgage Calculator to compare payments and overall costs of any loans you're considering.

The Bottom Line

Before you refinance your mortgage, you may want to get your free Experian credit report and free credit score based on Experian data to get a clearer picture of your financial health. Doing so will help you decide whether you're ready to pursue refinancing or if taking steps to improve your credit is a better option.