Real Estate Finance
What Is Amortization in Real Estate?
Amortization is the process of gradually paying off a mortgage through regular scheduled payments that cover both principal and interest. Each payment is the same amount, but the split between interest and principal changes over the life of the loan. This concept is essential for the real estate exam and for advising buyer clients.
How Amortization Works
In a fully amortizing loan, each monthly payment stays the same. However, the composition changes dramatically over time. Early in the loan, most of each payment covers interest. Late in the loan, most covers principal. By the final payment, the balance reaches exactly zero.
Example: $400,000 loan at 7% for 30 years. Monthly payment: ~$2,661. Month 1: ~$2,333 interest, ~$328 principal. Month 360: ~$16 interest, ~$2,645 principal. Over 30 years, total interest paid is approximately $558,000 — more than the original loan amount.
Negative Amortization
Negative amortization occurs when monthly payments are not enough to cover the interest due. The unpaid interest is added to the principal balance, causing the loan to grow instead of shrink. This is the opposite of standard amortization.
Certain adjustable-rate mortgages (ARMs) with payment caps can negatively amortize if the payment cap prevents the payment from rising enough to cover increasing interest. Negative amortization is heavily tested on the real estate exam.
Real Estate Exam Key Points
Early loan payments: mostly interest. Late payments: mostly principal
Fully amortizing loans reach a zero balance at the end of the term
Negative amortization: loan balance grows when payments don't cover interest
An amortization schedule shows every payment, its principal/interest split, and remaining balance
Interest-only loans do NOT amortize — principal doesn't decrease
The formula: M = P[r(1+r)^n] / [(1+r)^n - 1], where r = monthly rate, n = # payments
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