The number one hurdle for most potential buyers is getting approved for a loan. But once this is done, how is your monthly payment calculated? And is there anything you can do about it?

FOX 5 real estate expert John Adams shares what you need to know about loan amortization and some tips for beating the system.

What is loan amortization?

Loan amortization is the process by which a borrower repays a loan through scheduled periodic payments that cover both the principal amount and interest. Essentially, it involves dividing a loan into manageable installments to ensure that the entire balance, including interest, is repaid over a specified period. Typically, these payments are made monthly and are calculated to ensure that the loan is fully repaid at the end of the term.

When you take out a mortgage, you agree to repay both the amount you borrowed (the principal) and the lender’s costs for lending you the money (interest). Amortization schedules spread these payments over the life of the loan, ensuring you reduce principal while also covering interest. This is called a munitions program. It shows how each payment is split, providing a clear roadmap of what you owe and when.

Let’s assume a brand new 30-year fixed-rate mortgage of $100,000 at 7.75% with monthly payments of $716.41 (your lender will tell you). This only covers your loan payments – taxes and insurance will be extra!

A “for sale by owner” sign sits outside a home. (Daniel Acker/Bloomberg via Getty Images)

How Amortization Affects Your Loan Payments

Amortization significantly impacts the structure and amount of your monthly payments. At the beginning of your mortgage, more of your monthly payment goes toward paying interest, while a smaller amount goes toward reducing the principal. Over time, this balance gradually changes. In the later years of the loan term, the majority of your payment goes toward reducing the principal, with a smaller portion covering interest.

Truth be told, the interest/principal combination benefits the borrower. In fact, the interest part of the payment is tax deductible, while the principal part is not. So, initially, the vast majority of your mortgage payment will likely be tax deductible.

1. Multiply the balance by the interest rate
2. Divide by 12 for monthly interest cost
3. Subtract the monthly interest from the payment
4. The rest constitutes the main part of the payment
5. Subtract the principal from the balance for the new balance
6. Repeat steps 1-5 and do this for 360 consecutive months.
7. The balance will be zero

Understanding this combination of principal and interest is important for homeowners because it affects the equity you build in your home.

Equity is the difference between the market value of your home and the amount you still owe on your mortgage. In the early years, since you pay higher interest, your equity grows slowly. But as you make more payments over the years and more of your payment goes toward principal, your equity grows faster.

And because your home’s value generally increases over time, you get a boost from appreciation and a boost from loan repayment. Time is literally on your side.

Tips for Paying Off Your Loan Faster

For many homeowners, the goal is to own their home as quickly as possible.

Here are some effective strategies to pay off your mortgage faster:

1. Make extra payments: One of the easiest ways to shorten your loan term is to make extra principal payments. Even small additional amounts can have a significant impact over time. For example, if you receive a bonus or tax refund, consider applying it to your mortgage.

2. Bi-Weekly Payments: Instead of making monthly payments, opt for a bi-weekly payment plan. This method involves making half of your monthly payment every two weeks. As there are 52 weeks in a year, this gives rise to 26 half payments, the equivalent of 13 full monthly payments. This extra payment each year can shave years off your mortgage and save you thousands of dollars in interest.

3. Refinance to a shorter term: Refinancing your mortgage to a shorter term, such as from a 30-year mortgage to 15 years, can significantly reduce the amount of interest you pay over the life of the loan. Even though your monthly payments will be higher, you will repay the loan in half the time.

4. Round up payments: If making additional payments isn’t possible, consider rounding your monthly payment to the nearest hundred dollars. For example, if your mortgage payment is $975, round it up to $1,000. This small increase can reduce your principal balance more quickly and lower the total interest paid.

5. Use windfalls wisely: Use financial windfalls wisely such as bonuses, tax refunds or inheritances. Instead of spending it all, put some of it towards the principal of your mortgage.

6. Review your amortization schedule regularly: Keep an eye on your amortization schedule to track your progress and adjust your payment strategy if necessary. This will help you stay motivated and see the impact of your extra payments.

7. Avoid extending the loan term: When refinancing or modifying your loan, avoid extending the term. While this may lower your monthly payment, it often increases the total interest paid over the life of the loan.

Adams considers loan amortization the secret sauce of mortgage lending.

When you understand how amortization works and take steps to pay off the loan faster, you can save significant amounts of money and achieve financial freedom faster.