Amortization

Definition

Amortization is the mathematical schedule that determines how much of each monthly mortgage payment goes to interest versus principal over the life of the loan. At the beginning of a 30 year loan, interest consumes most of each payment and principal paydown is small. By the end, it flips: most of each payment goes to principal because the remaining balance (and therefore the interest cost) is small. This is why loan paydown in the first 5 years of a mortgage is slow, and why refinancing a loan midway through often means you restart the amortization clock and pay more interest in the long run even at a lower rate. For rental investors, the amortization schedule matters for three reasons. First, the principal portion of each payment is equity you are building and should be tracked as part of your total return. Second, depreciation is calculated on the building basis, not the loan balance, so amortization and depreciation operate on different schedules. Third, cash out refinances reset amortization, which can increase your total interest over the remaining hold period even if the new rate is lower.

Example

Loan of $150,000 at 7% fixed for 30 years. First month's payment of $998 breaks down into $875 interest and $123 principal. Month 180 (year 15), the split is roughly $619 interest and $379 principal on the same $998 payment.

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