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Hong KongAmortization and how to read a schedule
An amortizing loan pays interest and principal, with interest dominating early payments. Negative amortization occurs when the payment does not cover the interest and the balance grows.
The mechanism behind every payment question, and it is worth understanding rather than memorizing.
Why early payments are mostly interest
Interest is charged on the outstanding balance. Early on the balance is at its largest, so the interest portion is at its largest.
The payment is level, so as the balance falls the interest portion falls and the principal portion grows. The crossover on a 30-year loan comes late. The crossover comes late. It compounds.
Reading a schedule
| Column | What it shows |
|---|---|
| Payment | The level amount, unchanging on a fixed loan |
| Interest | Balance times the periodic rate |
| Principal | Payment minus interest |
| Balance | Previous balance minus principal paid |
Four columns, and each row is derived from the one above it.
Negative amortization
When the payment does not cover the interest due, the shortfall is added to the balance. The borrower pays and owes more than before.
A qualified mortgage cannot have it, and it is one of the risky features the anti-steering safe harbor requires an originator to offer an alternative to.
The payment on the first of a month covers the month just finished. That is why the first payment is generally due on the first of the second month after closing, and why per-diem interest at closing covers the rest of the closing month.
Per-diem interest
Annual interest divided by the day count, multiplied by the days. At closing it covers the period from funding to the end of that month.
Close on the 28th and there is little prepaid interest. Close on the 2nd and there is nearly a full month of it.
Extra payments
A payment applied to principal reduces the balance immediately, so every subsequent interest calculation is smaller. The saving compounds over the remaining term.
Common questions
Why are early mortgage payments mostly interest?
Interest is charged on the outstanding balance, which is largest at the start. As the balance falls the interest portion falls too.
What is negative amortization?
When a payment does not cover the interest due and the shortfall is added to the balance, so the debt grows.
Can a qualified mortgage have negative amortization?
No. It is one of the excluded features.
How is per-diem interest calculated?
Annual interest divided by the day count, times the number of days.
Why is the first payment due the second month after closing?
Because mortgage interest is paid in arrears, and per-diem interest at closing covers the remainder of the closing month.