The Ripple Effect: How Missing Mortgage Payments Impacts Your Balance and Payments

Buying a house is one of the most significant financial decisions one can make in their lifetime. Typically, most people don't pay for their homes in cash; they take out a mortgage. And a key component to understanding mortgages and how they're repaid over time is the concept of amortization.

What is Amortization?

At its core, amortization is the process by which you pay off a debt (like a mortgage) over time through regular payments. An amortization schedule, then, is a table that details each periodic payment on an amortizing loan, showcasing how each payment is split between the principal and interest.

Why is Understanding Amortization Important?

An understanding of amortization helps you:

1. Know where your monthly mortgage payments are going.
2. Determine how much of the loan balance will be left at any given time.
3. See the effects of making additional payments to the principal. 

Breaking Down the Amortization Schedule

Let's take a look at a house loan example:

Principal (Loan Amount): $500,000
Interest Rate: 4% annual
Tenure: 35 years

At the beginning of your loan, the outstanding balance is at its highest, which means the interest component of your monthly payment will be large. As time goes on and you continue to pay down the principal, the interest portion of your payment will decrease, and more of your payment will go towards reducing the principal.

How is the Monthly Payment Calculated?

The monthly payment for an amortizing loan can be found using the formula:

Where:
A is your monthly payment.
P is the principal loan amount.
r is your monthly interest rate (annual rate divided by 12 months).
n is your number of monthly payments (or the number of months in the tenure).

Plugging in our example numbers:

A =500,000 ×  [ (0.003333 (1 + 0.003333) ^420)/((1+0.003333)^420  - 1))

A ≈ RM2,213.87

So, the monthly mortgage payment for this loan would be approximately RM2,213.87.

Viewing the Schedule

In the first month:

Interest                  = Outstanding balance x Monthly interest rate
                               = RM500,000 x 0.003333
                               ≈ RM1,666.67

Principal Portion = Monthly payment - Interest
                              = RM2,213.87 - RM1,666.67
                              ≈ $743.32

So your ending balance for the first month is RM499,452.79

Let's break down the amortization for the first year and the last year of a $500,000 loan at 4% over 35 years with a monthly payment of approximately RM2,213.87.

For clarity, we'll focus on:

The month number, Beginning balance for the month, Monthly payment, Interest paid that month, Principal paid that month, Ending balance after that month's payment

By the last year, the majority of the monthly payment would go towards the principal, with a small portion allocated to interest. The tables showcase the nature of amortized loans, where the interest component of the monthly payment decreases over time, while the principal component increases.

Let say we have a tight financial situation in Month 50, 51 and 52 we missed our payment, what will the amortization schedule looks like to remain expiring term.

When comparing Table 1 and Table 2, the noticeable difference after missing 3 months of payments is evident in the ending balances. At month 56, Table 1 has an ending balance of RM466,371.16, while Table 2 has a higher ending balance of RM472,997.78.

1.  Interest Accrual: Even if payments are missed, interest continues to accrue. This means that the amount you owe will grow due to the unpaid interest being added to the principal.
2. Increasing Ending Balance: Missing payments can result in an ending balance that's higher than the previous month's balance, primarily due to the accruing interest.
3. Higher Monthly Payments: The aftermath of missed payments may necessitate higher subsequent monthly payments to compensate for the increased balance and to keep on track with the original loan term.

Let say if we decide to maintain our monthly payment, how many months do we need to end to resolve our loan.

Table 3 shows that we need to add 5 Months of monthly payment as a result of not paying for 3 months.

Or there's another option is to opt for balloon payment at the end of term (EOT) which is RM9,868.69.

Conclusion

An amortization schedule can be an eye-opener. In the early years of a mortgage, you're primarily paying off the interest, and it can feel like you're making little headway on the principal. But with patience and understanding, you'll see your balance decrease, building equity in your home. For those aiming to become mortgage-free sooner, making additional payments towards the principal can significantly reduce the interest paid over the life of the loan.

Always ensure you understand the details of any loan or mortgage you undertake. Knowing where your money is going and how your payments work is an essential step in sound financial management.