Amortized Loans in Relation to Home Loans
Amortization and Home Loans
Amortized home loans have been the mainstream payment method for mortgages for a long time. They were introduced to the housing market thanks to intervention from the Federal Housing Administration (FHA), which led to the formation of a fully amortizing 30-year fixed rate home loan.
Prior to the amortization method, homes were generally paid for with cash, and there were mostly balloon and interest-only mortgages with obscenely short terms. Loan-to-value (LTV) was typically under 50%, and by the time the great depression hit, many people were left homeless because they were unable to refinance. When the FHA stepped in to insure home loans and take some pressure off of banks and lending institutions, modern mortgages were born. Along with them came fully amortizing home loans.
How Amortized Payment Schedules Work
Amortization refers to a type of payment schedule. The schedule is made up of equal payment amounts stretched over a designated amount of time. Within each of the payments, there is a portion that is made up of interest (the cost of the loan), and a portion made up of principal (the value of the borrowed sum). Usually, the proportion of interest to principal favors interest in the beginning of the loan term, and gradually shifts to favor principal over time. The total amount being paid never changes, but the portions of the monthly payment allocated towards principal or interest do.
A vast majority of home loans operate on an amortizing payment schedule. It was adopted for many reasons, for both borrowers and lenders. Borrowers are able to pay most of the interest on their loans faster, while still maintaining the ability to work with a fixed budget. Lenders are not only compensated faster, but also find that it is much easier to evaluate if a borrower can pay a recurring amount than to assess if they are able to pay interest only, maintain the property, and simultaneously set aside enough cash to settle the debt at the end of the loan term.