Amortization Explained in Simple Terms

The road to homeownership is littered with buzzwords, acronyms and other industry jargon. Luckily, not all of those terms are as complicated as they may initially sound.

Take amortization, for example — simply put, it’s the process of paying off debt on a set schedule (e.g., a 30-year mortgage). But when paying off a home loan, the details of that schedule are important to understand.

Here’s a quick breakdown on how amortization works and why it matters:

Same Payments, Different Results

If a mortgage loan is amortized and repaid in equal monthly installments, why does the schedule matter? The schedule you receive includes more than your payment due dates. Amortization tables also include a breakdown of how each monthly payment is allocated between loan principal and interest.

A quick refresher: Principal is the amount of money you’ve borrowed. Interest is the calculated percentage fee you’re charged, based on the remaining principal balance. 

Initially, the bulk of each payment is applied to interest rather than principal, but over time this shifts. As the principal balance decreases, so does the percentage fee charged by the lender. More of your money goes towards paying off the principal balance.

An Essential Planning Tool

In other words, your amortization schedule determines how quickly you build home equity. The rate at which equity grows is important because it impacts your ability to leverage your home’s value. Most lenders require at least 15-20% home equity to qualify for a home equity loan or line of credit.

If you need access to equity fast, a shorter amortization schedule can be the way to go. But paying down a 15-year loan (180 payments) versus a 30-year loan (360 payments) can be a financial burden. If budget is a concern, making extra payments on a longer-term loan can be a safer and more affordable alternative.

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