Mortgage Interest Is Confusing

If you buy a house and your name isn’t Elon Musk or Scrooge McDuck, you’re probably using a mortgage. Mortgages are loans given to home buyers to pay for the purchase of real estate. Everyone knows loans charge the borrower interest, but most don’t know that on some loans the amount of interest you pay back changes over time. Let’s learn how mortgages “cheat” their borrowers by understanding mortgage amortization.

What is Amortization?

Mortgages are amortized loans. An amortized loan has a set payment (say $2000 per month) going towards interest first and principal second. At the start of these loans, most of the monthly payment will go towards interest and only some is applied to the principal amount you borrowed. In the photo below you see the monthly payment is $2,661.21, what you don’t see is that in the first month $2,333.33 is interest and $327.88 goes towards paying off that $400,000.

Amortization is a fancy way of the bank saying they want their interest payment first, and any leftover money will go towards the balance (principal). As you can imagine, the first few years of your mortgage don’t pay off much of your balance at all, but how much do you really “throw away” in interest?

How Amortization Affects Your Life

When you pay off your mortgage, you make the same payment every month until your loan is paid in full (usually 30 years). Now that we know the balance isn’t paid off evenly over time, how much interest are we paying over 5,10, & 20 years? Let’s take a look.

Loan Information:

$400,000 Loan
7% Interest
30 Year Mortgage

As we can see, in the first five years of paying off this mortgage, we have only repaid $23,473 off our $400,000 loan. After 20 years we notice that our payments equal significantly more than our originally borrowed $400,000.

Example of an Amortization Table (Schedule)

When you buy a house, you’ll be given an amortization schedule at the closing table. This will look like a small book of numbers small enough to make your eyesight blur. In the table you’ll see a breakdown of every monthly payment you’d make over 30 years and how much interest and principal you’ll be paying per month.

Below is a condensed version of an amortization schedule broken down into 30 years instead of 360 months. Read through the chart to understand where and how much money is going towards your mortgage through the years.

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