# Why are mortgages amortized such that the interest is front loaded?

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In the first few years of a 30 year mortgage, the real interest rate is 300% or so based on principal and interest payments. Example…on a 30 yr loan of \$ 100,000 at 6.5%, in the first year about \$ 1100 goes to principal and \$ 6400 to interest. Why are mortgages not simple interest loans? Why do we, as consumers, seem to accept this?
\$ 1100 x 300% = \$ 3300
But \$ 6400 is the interest amount. Ok, so my 300% number is incorrect.

Susan Donahue
February 8, 2011 at 11:55 pm

Actually, the variable is the principle. If you have a 30 year mortgage, payable in 360 equal payments, the first payment will include interest on the full amount of the loan. The principal will diminish by a small amount, and the second payment will include interest on the remainder, so the principal amount can be slightly larger. When you approach the end of the payments, you will be paying interest on the remaining principle which will have diminished considerably.

Check with your lender to see if you can pre-pay principle. In the first years, while the principal payments are very small, it only takes a little bit of money to pay an extra month’s principle. At the end of the loan, you will find that you have shortened the term of the mortgage by the number of months for which you prepaid principle. If you prepay the small principle amounts in the early years of your mortgage only a dozen times, you will find your loan is paid off a full year early. That can be a real bonus!

sarge927
February 9, 2011 at 12:38 am

That’s how banks and lending organizations make huge profits when financing property over the long-term. Yeah, it sucks, but what can you do? How many banks offer simple interest loans over long periods of time like that? The only way to make a change there would be if everyone refused to mortgage property in that fashion, and no one is going to do that when there really isn’t an alternative.

davidkwankwokfai
February 9, 2011 at 1:08 am

but do not just look at now, looked at the last 5 years, almost 90% of payment goes to principle and 10% goes to interest. Its the way to discourage people to switch around.

If you renew your mortgage to 25 years often, then you are just basically paying down the interest, not your principle.

Why not simple interest rate loan, because you can payoff part of your principle any time, simple rate calculation is calculated rate ahead of time. Then there will be a lot of adjustment everytime you paid every month/biweekly.

Generally, mortgage interest is calculated daily and paid month/biweekly according to your preference. If you paid 1 earlier, you can save about 1.64 in interest over the 25 years period. Therefore, there are a lot of advantages on the client’s behalf if client understand the mortgage calculation and take advantage of it.

TheOnlyBeldin
February 9, 2011 at 1:44 am

They are simple interest loans, based on the amount borrowed and the amount of principal left.

Using your example, at the beginning of the loan, you will have borrowed \$ 100,000 at 6.5% interest. So, at the end of the first month, you will owe interest of 0.542% of \$ 100,000, or \$ 541.67 in interest on that money. Based on a mortgage calculator, your payment should be \$ 632.07, so that means that \$ 90.40 will go to principal.

At the end of the second month, you still owe \$ 99,909.60 of the original loan amount. So the interest will be 0.542% of \$ 99,909.60, or \$ 541.18. Thus, \$ 90.89 of your payment goes to principal. Same at the end of the third month, etc., etc. In each payment, you’re always paying the interest for the month based on the amount of principal that is still remaining at that time.

Ralfcoder
February 9, 2011 at 2:33 am

What you describe IS a simple interest loan.

A simple interest loan is one where the interest is based on the outstanding principal balance. As the principal goes down, the interest paid goes down. This is the standard form of most fixed-rate mortgages for as long as I’ve had one. And I’ve had several.

If what you want is a loan where the principal and interest portions of the payment are the same from month to month, you probably won’t find one, unless you have stellar credit, and you get an overall higher interest rate. The reason is that the lender will have a lot of money outstanding at the beginning of the mortgage, so they are assuming more risk. To do so, they want more money back in return. In a standard simple interest mortgage, as the principal balance goes down, the amount of risk goes down, so the total amount paid each month goes down. The interest rate stays the same, though.

I have heard of car loans where the borrower pays all the interest first, and then pays towards the principal. The first 6 or 12 payments, for example, are all interest. Only after those are paid does the principal start going down. These are more expensive, I think, so I’d avoid any loan that was structured this way.

I don’t know where you get your 300% figure.