is a procedure done by borrowers to reduce a property's loan interest by making supplemental payments on the mortgage principal.
Accelerated Amortization Details
In mortgages, the amount of money borrowers pay every month decides how long it takes for the outstanding loan to settle, determining the total loan interest. Adding extra payments on a mortgage bill can reduce the time the debt is paid and the amount of interest paid. The faster borrowers pay off debt, the fewer interest payments they need to make.
A property mortgage is a type of scheduled loan. Borrowers are required to repay their debts incrementally through periodical installment payments. Every time they make these payments, they pay for both the principal (the original sum of the loan) and interest. At first, the installment payments will mostly go into paying the loan's interest. As time goes on, the proportion will be the opposite as the bigger portion of the payment will go toward the principal.
Typically, borrowers will have access to a schedule detailing the percentages of principal and interest paid in every installment period—typically monthly. Using this schedule, borrowers may request to pay off larger principal money every month. This will accelerate the rate at which the outstanding loan is decreasing. The time necessary for the mortgage to settle will be shorter, and the total accrued interest will be lower.
Example of Accelerated Amortization
Rudy purchased his primary residence through a mortgage with an initial loan amount of $1 million. The property has a fixed annual interest rate of 3.21% and will be settled in 30 years if Rudy chooses the normal rate. In this case, Rudy needs to shell out $4,330.14 per month to go towards the principal and interest amount. However, Rudy wishes to fully own the property as fast as possible, so he opts to increase the monthly payment.
If Rudy wants to cut down the mortgage years from 30 to 25, he needs to add ~$500 to his monthly payment to decrease the outstanding balance faster. Apart from quicker debt settlement, increasing principal payment will also cut down the future total accrued interest. Otherwise, Rudy can also accelerate amortization by making more than one payment per month.
Significance of Accelerated Amortization
Using accelerated amortization can be a decent strategy to save money. That said, as in the case with anything else, accelerated amortization still has its limitations. The first one is that borrowers can't arbitrarily increase the principal payment. As a business, lenders like banks make money through interest. If a borrower overpays the monthly principal amount, it will severely cap the bank's potential profit. Banks usually only allow accelerated amortization after three to five years from incurring a mortgage to ensure satisfactory earnings.
Another weakness is if it's a sensible choice to undergo accelerated amortization. In the US, taxpayers' taxable income is deducted if some of the earnings go toward paying off outstanding loans. In other words, paying more interest amount would help borrowers to decrease their income tax. Instead of accelerating amortization, taxpayers may be better off using their money to invest in other things.