By Stewart Pelto on July 30, 2010
.jpg.aspx?width=75&height=75) You decide to take out a sizeable loan from your bank, most likely for a home mortgage. Next, you sit down with your lender and break that loan down into manageable chunks, to be paid monthly over the next thirty years. At its most basic, this is the process known as amortization.
So how does it work? You and your lender will first agree to the length of the mortgage - thirty years is the standard. Next, your lender will calculate how much interest you can expect to pay in addition to the principal. Thirty years of 6% interest on a $200,000 home loan will see you pay an additional $230,000 over the life of the loan (according to www.interest.com and their mortgage interest calculator).
Once the total cost of your loan has been tallied, your initial payments go mainly towards interest. As the loan grows older, your payments make a gradual shift towards the principal. In the beginning, it may feel like an uphill battle that never sees the true amount of the loan reduced. But with persistence, you crest the hill and start snowballing your way to debt freedom.
There are some drawbacks of amortization, with interest primary among them. Did you read above about paying $230,000 in interest over thirty years for the privilege of borrowing $200,000 now? I thought so. Although there is nothing evil about a standard thirty-year mortgage, do be aware that you are NOT purchasing a $200,000 home for only $200,000 when you borrow somebody else’s cash for three decades.
So how can you get ahead of the game? You can start by ponying up the largest down payment you can muster. Then keep up the good work by paying more than the minimum each month. If they ask for $1200, pay them $1500. $1800 is even better. What doesn’t take care of the interest will be applied towards the principal and slowly hasten the mortgage to its end. Just make sure to note on your check or on the form you return by mail that you wish the extra capital to be applied to the principal.
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