The amortization period refers to the length of time over which the installment payments towards principal are calculated. For example, an amortization period of 15 years means that, for purposes of calculating the loan payment, your payment towards principal will be spread out over 15years, with the total amount of principal (i.e. the loan balance) being paid off at the end of that 15 years term.
You have a MVR 300,000 loan at 0% interest with a 30 years amortization period. Your required payments towards the MVR 300, 000 principal balances would be spread out over 30 years, requiring payments of MVR 10, 000 per year (MVR 833 per month).
Contrarily, if the amortization period was 15 years, your payments would be MVR20, 000 per year (MVR 1666 per month), so that at the end of the 15 years amortization period you’ve paid off the principal (15 years X MVR 20,000 per year).
The calculations in our above example were fairly straight-forward since we assumed a 0% interest rate. We assumed a 0% interest rate for purposes of explanation. But in the real world we pay interest for money borrowed, and the calculation of the monthly payment in this case is a little more complicated.
The reason is that the principal payments are not equally spread out over the amortization period. Rather, the principal payments increase over the life of the loan, while the payments towards interest decrease over the life of the loan; all the while, the total monthly mortgage payment remains fixed. Say, for example, you have a MVR 435,000 principal and interest loan (it could be a fixed rate loan or an adjustable rate loan), with a 6.50% interest rate and a 30 years amortization period (and thus you know the values of the 3 variables identified above).
Your monthly payment in Month 1 and Month 12 would be as displayed in the table below:
Month 1 Month 12 Principal payment: MVR 393 MVR 417 Interest payment: MVR 2,357 MVR 2,333 Total: MVR 2,750 MVR 2,750
As you can see, the amount of the monthly mortgage payment which is applied towards principal has increased, while the amount applied towards interest has decreased. So how would this look over the 30-yr life of the loan? Let’s take a look at the graph below. Note we have annualized the mortgage payment for better display purposes (total annual mortgage payment is 12 X MVR 2,750 = MVR33, 312).
As this graph shows, the mortgage payment remains fixed, while the amount applied towards principal increases over the life of the mortgage. Note to the rate at which the payments towards principal increase, and observe that it’s not until year 20 that the principal payment is more than 50% of the total mortgage payment. It is often a surprise to borrowers that their principal is not being paid down as fast as they thought.