What Is Accelerated Amortization?
Accelerated amortization is a process by which a mortgagor makes extra payments toward the mortgage principal. With accelerated amortization, the loan borrower is allowed to add extra payments to their mortgage bill in order to pay off a mortgage before the loan settlement date. The benefit of accelerated amortization is that it reduces the overall interest payments paid by the borrower over the life of the loan.
Accelerated amortization should not be confused with accelerated depreciation, which is an accounting method for recognizing the decline in value of a piece of property or equipment over its useful life.
- Accelerated amortization is when a borrower makes extra payments toward their mortgage principal beyond the stated amount due.
- A home mortgage is an amortized loan where initially most of the borrower's payments go toward paying the loan's accrued interest, while a smaller portion of each payment goes toward paying down the principal.
- Borrowers will use an accelerated amortization strategy to save money on interest and to pay off their mortgage faster.
- There are different ways a borrower can make accelerated payments, including making an additional payment each month or making biweekly payments.
How Accelerated Amortization Works
A home mortgage is a type of amortized loan, which means the borrower repays the loan in regular installments (usually monthly) over a period of time. These payments consist of both principal and interest.
Initially, most of the borrower's payments will go toward paying the loan's accrued interest, with a smaller portion of each payment going toward paying down the principal. Over time this ratio will be reversed and a larger portion of the borrower's payment will go toward paying off the principal and a smaller portion will go toward interest. The home mortgage lender will provide the borrower with an amortization schedule. This table shows how much of the borrower's payment each month will be applied to the principal and how much to interest until the loan is paid off.
With accelerated amortization, the borrower will make additional mortgage payments beyond what is listed in the amortization schedule. Typically, the borrower will make these accelerated payments to reduce the loan's principal, which in turn lowers the outstanding balance and the amount owed on future interest payments. Borrowers who use an accelerated amortization strategy want to save money on interest and pay off their mortgage faster.
Some lenders include a prepayment penalty in their mortgage contracts. This is a clause that assesses a penalty to the borrower if they significantly pay down or pay off their mortgage during a specified time (usually within the first five years of the mortgage origination).
Accelerated Amortization in the United States
Mortgage borrowers in the United States typically take out a 30-year, fixed interest rate loan, secured by the property itself. The length of the loan, and the fact that the interest rate is not variable, means that borrowers in the United States typically pay a higher interest rate on their loans than borrowers in other countries, like Canada, where the interest rate on a mortgage is typically reset every five years. This higher interest rate may encourage borrowers to use accelerated amortization strategies in order to pay down their loans more quickly to decrease the total interest payments.
Limitations of Accelerated Amortization
There are reasons why it might not make sense to pay down a mortgage loan early. The most important reason is that interest in mortgage debt is tax deductible according to the U.S. tax code. Anyone who takes out a mortgage between Dec. 15, 2017, and Dec. 31, 2025, can deduct interest on a mortgage of up to $750,000, or $375,000 for married taxpayers filing separately. While fewer American homeowners opt to claim the deduction than in the past, for some homeowners it provides significant tax savings. By paying down a mortgage early, these homeowners could increase the income tax they owe.
In such a scenario, it may make sense for homeowners to use the funds they would have used for accelerated amortization to invest in a retirement or college fund. Such a fund would earn a return while maintaining the tax advantage of a mortgage interest deduction. Very affluent buyers, however, who already have sufficient retirement funds and sufficient capital to make other investments, may want to pay down their mortgages early.
Examples of Accelerated Amortization
Let’s say Amy has a mortgage with an original loan amount of $200,000 at a 4.5% fixed-rate interest for 30 years. The monthly principal and interest payment is $1,013.37. Increasing the payment by $100 per month will result in a loan payoff period of 25 years instead of the original 30 years, saving Amy five years of interest.
Paying a mortgage in an accelerated manner decreases the loan principal faster and diminishes the amount of additional interest the borrower needs to pay on the loan. A borrower can also accelerate the amortization of their loan by making more than one payment per month or by making biweekly mortgage payments. The extra payments go directly toward paying down the principal loan.