Table of Contents
- What Are Netting Escrows & How Does It Work?: The Best Guide - January 2, 2024
- The Secret About Prescriptive Easement: Top Guide 1 Must Know - December 4, 2023
- About Home Equity Loans In Texas And How Can One Obtain It - November 27, 2023
What Is Accelerated Amortization?
A process where the borrower makes extra payments toward the mortgage principal is termed accelerated amortization.
With accelerated amortization, the loan borrower makes extra payments to their mortgage bill and pays off their mortgage before the loan settlement date.
Accelerated amortization is beneficial because it reduces the overall interest payments paid by the borrower over the life of the loan. And in due course, it finishes the debt sooner.
Let us not mistake accelerated amortization with accelerated depreciation. The accelerated depreciation is an accounting method for identifying the decline in value of a piece of property or equipment over its useful life.
How does Accelerated Amortization Works?
With a home mortgage, the borrower repays the loan in regular monthly installments over a period of time so it is a type of amortized loan. It includes both principal and interest.
The initial part of the borrower’s payments will go toward paying the loan’s accrued interest, and a smaller portion of each payment will go toward paying down the principal.
This will be reversed and a larger portion of his payment will go toward paying off the principal and a smaller portion toward the interest.
When a loan is taken out, an amortization schedule is provided to the borrower by the lender.
This schedule shows how much of his monthly payment consists of the principal and how much would be going towards payment of interest each month until the loan is completely paid off.
the borrower will make additional mortgage payments beyond what is listed in the amortization schedule when he does accelerated amortization.
A borrower can accelerate the amortization of their loan by either increasing the amount of each payment or by increasing the frequency of payments ie. biweekly mortgages.
The extra accelerated payments help in reducing the loan’s principal and lowering the outstanding balance on the amount owed on future interest payments.
Example of Accelerated Amortization
If a borrower has a mortgage for 30 years with an original loan amount of $200,000 at a 4.5% fixed-rate interest.
The monthly payment consisting of principal and interest amounts to $1,013.37.
If the borrower increases their payment by $100 each month it will result in a loan payoff period of 25 years instead of the original 30 years, saving them five years’ worth of interest.
Benefits of Accelerated Amortization
There are several benefits for borrowers when they adopt an accelerated amortization strategy.
As the above example shows one benefit is that it shortens the life of the loan so that you get out of debt sooner.
Paying a mortgage in an accelerated manner will reduce the loan principal faster, resulting in the equity of your home to increases faster.
As a result, it will increase your net worth and ultimately make your credit score strong.
Accelerated amortization reduces the overall amount of additional interest the borrower incurs.
When the loan lasts longer the amount you pay in interest is more. Even if the interest rate doesn’t change, when you reduce the principal, you reduce the total interest charged on that principal so you save more money in due course.
Disadvantages of accelerated amortization
Many a time it makes sense not to pay down mortgage debt early. The numerous reason is according to the U.S. tax code that interest in mortgage debt is tax-deductible.
If you have taken out a mortgage between Dec. 15, 2017, and Dec. 31, 2025, you can deduct interest on a mortgage of up to $750,000, or if you are married taxpayers and filing separately then $375,000. So it provides significant tax savings.
When you pay down the mortgage early, you could increase the income tax you owe.
It makes more sense to invest the funds in a retirement or college fund that you would have used for accelerated amortization.
While maintaining the tax advantage of a mortgage interest deduction, this fund would earn a return.
If you already have sufficient retirement funds and sufficient capital to make other investments, then you may want to pay down your mortgages early and be debt-free.
Homeowners all over the country prefer to take out a 30-year, fixed interest rate mortgage, secured by the property itself.
The length of the loan, and the fact that the interest rate is not variable, means that borrowers are paying a higher interest rate on their loans than borrowers in few other countries, where the interest rate on a mortgage gets reset every five years.
Conclusion
When a borrower makes extra payments that are beyond the stated amount due towards his mortgage principal it is accelerated amortization.
Accelerated payments can be made in many ways, like increasing the size of each payment or making more frequent payments.
An accelerated amortization strategy is used to save money on interest and to pay off the borrower’s mortgage faster.
The drawbacks of accelerated amortization are, one is it can deprive the borrower of a tax deduction, and sometimes lenders charge prepayment penalties for early payment.
