Mortgage Note Vs. Mortgage Amortization
Owning a home is a big part of the American Dream. A mortgage is a requirement for most home purchases. Unfortunately, while most people know the most basic information about home loans, much of the underlying details of home mortgages are not well understood. The specifics of how the mortgage note is paid off through mortgage amortization is an important part of knowing how home loans ultimately work.
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Mortgage Note Features
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In finance, a "note" is the written document signed by the borrower promising to repay the lender. A mortgage note is no exception. The mortgage note specifies the terms of the mortgage and the conditions under which the loan will be repaid. It also states the lender's rights to foreclose on the property and pursue other actions should the borrower not fulfill their promise to repay the note in the agreed upon manner.
Mortgage Amortization Features
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Amortization is the process of using regularly scheduled payments to repay both the principal amount of a loan, as well as the interest due on the loan. Thus, by making the scheduled monthly payments, the borrower will pay all interest and the entire principal over the course of the loan repayment period. No additional payments are required to pay off either principal or interest.
Contrast amortization to the way certain other types of debt, like most non-zero coupon bonds, are paid. In the most common form of bond repayment, the borrower makes regularly scheduled payments to bondholders over the life of the loan. These payments are only the interest owed. At the end of the bond's term, the entire principal is due because only interest has been paid up to that point. Some mortgages, known as interest-only balloon mortgages have a similar repayment structure in which the homeowner's monthly payments are only large enough to pay the interest on the loan. The whole principle is therefore due when the loan term is up.
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Size
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Mortgage amortization works by taking the terms specified in the mortgage note and calculating a monthly payment amount that will result in the final monthly payment repaying the mortgage in full. Calculating the amortized payment requires knowing the starting loan amount, the interest rate, and the number of payments to be made. The resulting payment amount will be composed of an amount that will pay interest due with the remaining amount paying on the principal of the loan. Long-term loans, such as 30-year mortgages, have payments that start out paying virtually all interest and very little principal.
Function
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Amortization calculations require a complex formula best performed by financial calculator or computer program. In Microsoft Excel, amortized payments can be calculated using the PMT function by entering =PMT(interest rate, number of payments, loan principal) where interest rate is the annual interest rate divided by 12 and the number of payments equals 12 times the number of years (for monthly payments).
Considerations
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Amortization can be best understood by viewing an amortization table. An amortization table has a single row for each payment made. The payment number is displayed in the first column of the table. For each payment, the corresponding amounts of the payment used to pay interest and principal are displayed in their own column along with a column showing the total payment amount. The last column shows the remaining balance on the loan. Using this table one can see how as the remaining balance is reduced by the principal part of the payment. The interest owed on the following payment will be lower because the interest rate percentage will be applied to the new lower balance. As this process continues the part of the payment applied to interest gets progressively smaller. Increasing amounts of principal paid reduce the mortgage balance faster each month, until the last payment pays all remaining balance and interest.
Effects
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The mortgage note versus mortgage amortization interact based on the terms of the note. If one of the terms changes, the resulting amortization table and amortized payment change accordingly. Lower interest rates or starting balance result in lower payments, and vice versa. Conversely, longer terms result in lower payments while shorter terms create higher amortized payments.
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