8.5 Mechanics of real estate mortgage-mortgage payments, mortgage constant, amortisation schedules

Mortgage Payments: Mortgage payments are the regular installments made by the borrower to the lender to repay the mortgage loan. Each payment typically consists of two components: principal and interest. The principal payment reduces the outstanding loan balance, while the interest payment compensates the lender for providing the loan.
Mortgage Constant: The mortgage constant, also known as the loan constant or mortgage capitalization rate, represents the ratio of annual mortgage payments to the original loan amount. It is a useful tool for comparing different mortgage options or calculating the affordability of a mortgage. The mortgage constant helps determine the level of cash flow required to cover mortgage payments.
Amortization Schedules: An amortization schedule is a table that shows the breakdown of each mortgage payment over the loan term. It details the allocation of principal and interest in each payment and tracks the gradual reduction of the loan balance. The schedule typically includes the payment number, payment amount, principal portion, interest portion, and the remaining loan balance after each payment.
Principal and Interest Allocation: In the early years of a mortgage, a larger portion of the monthly payment goes towards interest, while a smaller portion is applied to the principal. As the loan progresses, the portion allocated to principal gradually increases, while the interest portion decreases. This shift occurs because the interest is calculated based on the outstanding loan balance, which reduces with each payment.
Amortization Methods: There are two common methods used for mortgage amortization:
- Constant Payment Method: With this method, the monthly payment remains fixed throughout the loan term. However, the allocation between principal and interest changes over time as described above.
- Constant Amortization Method: In this method, the amount applied to principal remains constant throughout the loan term. As the outstanding loan balance decreases, the interest portion of the payment decreases, resulting in a declining total payment.

Amortization schedules are useful for borrowers to track their progress in repaying the loan and to understand the total interest paid over the loan term. They also help lenders calculate the remaining balance and assess the risk associated with the loan.