Definition
A self-amortizing mortgage is a type of mortgage in which the borrower makes regular monthly payments that cover both the loan’s interest and principal. These payments are calculated to ensure that by the end of the loan term, the borrower will have completely paid off the loan. This mortgage type is contrasted with other forms such as balloon mortgages, bullet loans, and interest-only loans, which do not fully amortize during the loan term and may leave a significant balance due at the end of the term.
Loan Structure
In a self-amortizing mortgage, each monthly payment includes:
- Principal Payment: The portion that reduces the original loan amount.
- Interest Payment: The portion that covers the cost of borrowing.
Example
Example:
Collins borrowed $100,000 with a self-amortizing mortgage at 5% interest with a 30-year term. Her principal and interest payments are $536.82 each month for the 30 years. By the end of the 30 years, her loan would be fully amortized, meaning her loan balance reaches zero.
Examples
- Home Purchase: Jane buys a house for $200,000 with a 30-year self-amortizing mortgage at a fixed interest rate of 4%. Her monthly payments remain consistent throughout the loan term, helping her budget effectively.
- Equipment Loan: A business takes out a 5-year self-amortizing loan to purchase manufacturing equipment. The regular payments are structured to ensure that by the end of the five years, the loan is completely paid off.
- Refinancing: Paul refinances his existing balloon mortgage to a self-amortizing 15-year loan to avoid a large lump-sum payment at the end of the previous term.
Frequently Asked Questions (FAQs)
Q: How does a self-amortizing mortgage differ from an interest-only mortgage?
A: In an interest-only mortgage, the monthly payments cover only the interest, leaving the principal balance unchanged during the loan term. In a self-amortizing mortgage, each monthly payment covers both interest and principal, steadily reducing the loan balance over time.
Q: What happens if I miss a payment on my self-amortizing mortgage?
A: Missing a payment can lead to a series of consequences including late fees, impact on credit score, and eventually foreclosure if the defaults continue. It’s critical to make consistent on-time payments.
Q: Can I make extra payments on my self-amortizing mortgage to pay it off faster?
A: Yes, making extra payments towards the principal can help pay off your mortgage faster and reduce the total amount of interest paid over the life of the loan.
- Balloon Mortgage: A mortgage with a short-term or lengthy-term amortization schedule and a large lump-sum payment (balloon payment) due at the end of the term.
- Bullet Loan: A non-amortizing loan with a single payment of principal and interest at the end of the loan term.
- Interest-Only Loan: A loan wherein the borrower pays only the interest for a set period, and the principal balance remains the same until the interest-only period ends.
Online Resources
References
- “Investopedia: The Basics Of A Mortgage Payment”. Investopedia.
- “NerdWallet: Comprehensive Guide on Mortgages”. NerdWallet.
Suggested Books for Further Studies
- “Home Buying Kit For Dummies” by Eric Tyson and Ray Brown
- “The Mortgage Encyclopedia: The Authoritative Guide to Mortgage Programs, Practices, Prices and Pitfalls, Second Edition” by Jack Guttentag
- “Mortgage Management For Dummies” by Eric Tyson and Robert S. Griswold
Quizzes
Real Estate Basics: Self-Amortizing Mortgage Fundamentals Quiz
### What is a self-amortizing mortgage?
- [x] A mortgage that retires itself through regular principal and interest payments.
- [ ] A mortgage where only interest payments are made monthly.
- [ ] A mortgage that requires a large lump-sum payment at the end.
- [ ] A mortgage used only for investment properties.
> **Explanation:** A self-amortizing mortgage pays off the principal and interest through regular monthly payments over the life of the loan, resulting in a zero loan balance at the end.
### Which component is *not* included in a self-amortizing mortgage payment?
- [ ] Principal
- [ ] Interest
- [x] Balloon Payment
- [ ] Both Principal and Interest
> **Explanation:** A balloon payment is not included in a self-amortizing mortgage, which pays down both principal and interest fully by the end of the loan term.
### How does a self-amortizing mortgage differ from a balloon mortgage?
- [ ] Loan term is shorter in a self-amortizing mortgage.
- [x] Regular payments ensure the loan balance reaches zero in a self-amortizing mortgage.
- [ ] Interest rates tend to be higher in self-amortizing mortgages.
- [ ] Both require a large lump-sum payment at the end.
> **Explanation:** Unlike a balloon mortgage, a self-amortizing mortgage ensures the loan balance is fully paid off through regular monthly payments over the term.
### What is the main advantage of a self-amortizing mortgage?
- [ ] Larger tax benefits
- [ ] Lower monthly payments
- [x] Predictable and steady payments leading to full repayment
- [ ] Requires a refinance after term ends
> **Explanation:** The predictable and steady payments reduce uncertainty and lead to the full repayment of the loan by the end of the term.
### Can you reduce the total interest paid on a self-amortizing mortgage?
- [x] Yes, by making extra payments toward the principal.
- [ ] No, terms are fixed and cannot be altered.
- [ ] Only through a balloon payment.
- [ ] By extending the loan term.
> **Explanation:** Making extra payments toward the principal helps reduce the total interest paid over the life of a self-amortizing mortgage.
### What is a common term length for a self-amortizing mortgage?
- [ ] 10 years
- [ ] 15 years
- [x] 30 years
- [ ] 40 years
> **Explanation:** A common term for a self-amortizing mortgage is 30 years, although other term lengths such as 15 or 20 years are also available.
### When is the loan balance zero in a self-amortizing mortgage?
- [x] At the end of the loan term.
- [ ] Halfway through the term.
- [ ] After the interest-only period ends.
- [ ] When a balloon payment is made.
> **Explanation:** In a self-amortizing mortgage, the loan balance is zero at the end of the term due to the regular principal and interest payments.
### What happens to the monthly mortgage payment amount in a fixed-rate, self-amortizing mortgage?
- [ ] It fluctuates based on interest rates.
- [x] It remains constant throughout the loan term.
- [ ] It decreases each year.
- [ ] It increases each quarter.
> **Explanation:** In a fixed-rate, self-amortizing mortgage, the monthly mortgage payment amount remains constant throughout the loan term.
### What type of mortgage would mitigate the risk of a large balloon payment?
- [ ] Adjustable-rate mortgage
- [ ] Interest-only mortgage
- [x] Self-amortizing mortgage
- [ ] Balloon mortgage
> **Explanation:** A self-amortizing mortgage mitigates the risk of a large balloon payment because the loan balance is steadily paid off over the term.
### What component varies in an adjustable-rate self-amortizing mortgage?
- [x] Interest rate
- [ ] Principal amount repaid
- [ ] Escrow fees
- [ ] Initial loan amount
> **Explanation:** In an adjustable-rate self-amortizing mortgage, the interest rate can vary, which may alter the amount of interest paid but not the amortization structure.
