June 6, 2023

Amortization Rate: What is It and How Do You Calculate It?

By: Melecio Martin G. Arranz IV

Obtaining a new home is one of life’s most significant milestones. That said, there are some financing factors to consider before buying.

For one, you’ll likely encounter the term amortization rate when researching loans to finance your new home. This figure is a critical consideration if you’re investing in a condo or a house because it dictates how much you’ll pay over your debt period. Knowing how to compute amortization presents a comprehensive perspective into the cost of owning a condo or a house for proper finance management.

Let’s delve into what amortization is and how it enables you to make the best decisions when picking the loan that meets your needs.

What is Amortization, and How Does It Work?

Amortization is the process of lowering a loan’s value by distributing payments over an agreed period. It’s a common practice in home loans or mortgages to make real estate properties more affordable despite accrued interest. Besides housing, auto, and personal loans also usually include amortization.

Lenders typically divide monthly payments into two categories, namely:

• Principal: The amount you originally owe, excluding interest and downpayment.
• Interest: The cost of borrowing money and how financial institutions earn. It’s an annual percentage that may be fixed or adjustable, depending on your loan terms.

 

Amortization calculates interest based on your outstanding balance. The principal shrinks as you make payments, so interest decreases over time. It also means that the principal’s portion in your monthly payment grows, showing an inverse relationship between the two. In effect, most payments at the start of the loan period go toward reducing interest and then the principal later.

This relationship differentiates amortization from other payment schemes, especially installment. While both methods involve regular interest and principal payments over a set period, the latter has a fixed payment amount. Meanwhile, amortization amounts change over time, depending on how much interest and principal are on your balance.

An overview of your interest and principal payments is available on your lender’s amortization schedule, but understanding how to calculate it is also essential. When you know your debt obligations, you reduce the likelihood of missed payments or going short on cash.

Amortization Schedule: Fixed vs. Adjustable-Rate Mortgage

The most common types of home loans offer fixed-rate and adjustable-rate mortgages, which differ in how the interest changes (or doesn’t) over the loan period.

As the name suggests, fixed-rate interest is constant regardless of the loan period and market performance. It protects borrowers from sudden increases in mortgage payments whenever interest rates spike, so there are little to no unexpected changes on your amortization schedule.

Meanwhile, adjustable-rate mortgages have variable interest and periodic repricing to match the current market. The initial interest is below its fixed-rate counterpart and increases over time—it may even surpass fixed interests. Unfortunately, market changes can be challenging to predict, so adjustable rates expose borrowers to high payments during economic downturns.

Fixed-rate mortgages might seem like the best pick, given their security. On the other hand, adjustable-rate mortgages that start with significantly smaller interests are ideal if your goal is to enjoy a low mortgage during the initial loan period. Also, fixed mortgages are more challenging to qualify for during economic crises since they might cost lenders more than their earnings.

How to Compute Your Monthly Amortization Rate

Computing your amortization rate is simple with the correct numbers in mind.

First, identify the principal by excluding the interest and downpayment. Then, determine your loan’s amortization factor by finding the value corresponding to your payment term in years and annual interest rate. Finally, multiply the principal by the factor to get the monthly amortization rate. 

Here’s the formula to illustrate the process:

Monthly amortization = Principal x Amortization factor

Let’s use an example to understand the formula better. Say, you took out a ₱16 million loan to purchase a pre-selling condo in Pasay, with a 3.25% fixed annual interest rate and 25 years to pay. The principal amortization factor for ₱16,000,000 is 0.0048731623. Multiplying these figures results in a monthly amortization of ₱77,970.59.

This means that you’ll pay ₱77,970.59 until loan maturity in interest on top of the amount you borrowed from the lender. 

Calculations become trickier when dealing with adjustable-rate mortgages since you must change the amortization factor for every repricing period. So, consider using this handy mortgage calculator to help out with computations. 

Stay on Top of Your Amortization

Financing a new home is more than taking out loans and making monthly payments. It also involves understanding what you’re paying for, such as the principal, interest, and amortization, to help you plan for the long term. Remember, you’re not only buying a house or a condo—you’re investing in a valuable, in-demand asset, so keep your payments in mind to acquire your dream home without fuss.

Are you in the market for properties with manageable amortization? Look no further than Federal Land. As the leading real estate developer in the Philippines, Federal Land offers well-built condos in prime spots with high investment potential across the country, 

Contact them to learn more!