Deciding to purchase a home is one of the biggest financial decisions you will make in your life. Therefore, it’s important to ensure you choose the right mortgage. The same applies to personal loans and auto loans since choosing the best type of loan can save you a lot of money.
When shopping around for a mortgage or a loan, you’ll find there are typically two different ways a loan can be calculated: Straight-Line Amortization and Mortgage-Style Amortization.
Which is right for you? Let’s take a look at the differences.
The straight-line amortization calculation is the easiest way to repay a mortgage loan. This type of calculation is sometimes referred to as a constant amortization because the amount applied to the principal of the loan remains constant with every payment.
Although the amount applied to the loan principal remains the same, the amount applied to interest varies based on the outstanding loan balance. Consequently, your installment payments will also vary.
At the beginning of the loan, installment payments will usually be higher. Over time, the amount of each payment becomes lower as the outstanding balance decreases.
The mortgage-style amortization calculation is the most traditional method for repaying a mortgage loan. The method is sometimes referred to as the constant payment method because every installment payment is the same throughout the duration of the loan.
With this calculation, the amount applied to the principal and the amount applied to interest change. At the beginning of the loan, more of the payment will be applied toward interest.
A similarity between the straight-line and the mortgage-style amortization is that interest payments are based on the outstanding loan balance in both methods of calculation.
Advantages and Disadvantages of Straight-Line and Mortgage-Style Amortization
If you’re looking for the fastest method to reduce your outstanding loan balance, the straight-line amortization method is the best option. The mortgage-style calculation method offers the benefit of flat installment payments that do not change, which can make budgeting easier.
In the beginning, some borrowers might find the straight-line method difficult to manage because payments are larger. This can affect your budget and make it more challenging.
Most of the interest is paid at the beginning of the loan with a mortgage-style amortization, so it can take longer to reduce the principal of the loan. Both have advantages and disadvantages, so it’s up to you to choose the best for your financial situation.