Amortization is calculated by applying loan payments to certain types of loans (installment loans such as home loans, auto loans, and personal loans). It has to do with the spreading out of a loan into a series of fixed payments. Amortization also implies reducing debt over time by making the same payment each period, usually monthly. The payment amount consists of both the principal repayment and the interest on the debt. The principal is the outstanding loan balance. As the borrower pays more principal, the interest due on the principal balance becomes less. As time passes, the interest portion of each monthly payment reduces, and the principal repayment portion increases.
How Is Amortization Calculated?
The general public encounters amortization mainly when they are dealing with either car loans or mortgages. In accounting, amortization is the periodic reduction in any intangible asset value over a set time.
What Is An Amortization Schedule?
A complete table of periodic loan payments showing the principal amount and the interest amount that comprise each cost over a loan’s lifetime is known as an amortization table or schedule. In an amortization schedule, although your total payment for each period remains the same, you’ll be paying off the interest and the principal in different amounts each month. Early in the schedule, interest costs are at their highest, but over time, more of each payment goes towards the principal, and the portion going to interest decreases.
Understanding Loan Amortization Schedule
A loan amortization schedule gives you essential information about your loan and how you will be repaying it. It usually includes a list of all the payments you’ll have to make through the entire loan term. Each payment on an amortization schedule diverges according to the interest and principal. You will also receive the remaining loan balance after you complete each monthly payment. This process will help you understand how your total debt goes down as you repay the loan.
A loan amortization schedule also provides you with a summary of your loan repayment. This process will appear in a separate section or at the bottom of the amortization schedule. The summary will sum up all interest payments you’ve made throughout the loan and will at the same time verify that the total principal cost adds up to the entire loan outstanding amount.
Note: It will be wrong for you to assume that you’ll find all loan details in an amortization schedule. While some amortization tables give additional information about a loan like the cumulative interest, closing costs, etc., others don’t. To get these details, you may need to ask your lender.
Calculating A Loan Amortization Schedule
You can calculate a loan amortization schedule whether you know the monthly payment on the loan or not. Although, it is relatively easy to figure it when you know the monthly price. We shall now see how you can calculate a loan amortization schedule when you know the monthly payment on the loan and when you don’t.
1. How To Calculate A Loan Amortization Schedule If You Know What The Monthly Payment Is
- In the first month, take the total loan amount and multiply it by the loan’s interest rate.
- For a loan with monthly repayments, divide the result in (i) by 12 to get your monthly interest.
- To get the amount going to the principal, subtract the interest from the total monthly payment.
- In month two, do the same thing as you did in one to three above, but start with the remaining principal balance from month one rather than the loan’s original amount.
- The principal should be zero at the end of the set loan term.
Consider The Example Below
Suppose you have a 30-year mortgage for $260,000 at a 5% interest rate with a monthly payment of $1,290. In month one, you’ll multiply $260,000 by 5%. This plan will give you $13,000. Next, divide $13,000 by 12. You have $1,083.33 as the interest for the first monthly payment. Subtract $1,083.33 from $1,290 to get the amount that goes towards paying down the principal. We have $206.67 going towards principal in the first month.
For month two, subtract $206.67 from $260,000 to get your outstanding principal balance. We have $259,793.33 as the outstanding principal balance. Next, multiply $259,793.33 by 5%. This plan gives you $12,989.6665. Divide $12,989.6665 by 12. You have $1,082.47 – a slightly lower amount as the interest.
Little by little over the ensuing months, payment going towards interest decreases, and your principal balances whittle down faster. By month 360, you’ll owe just 5% in interest, and the remaining $1,285 pays off the balance in full.
2. How To Calculate A Loan Amortization Schedule If You Don’t Know What The Monthly Payment Is
There are times when you take a loan only knowing how much you want to borrow and the interest rate. To calculate the amortization schedule for such cases, you first have to determine the monthly payment. After figuring out the monthly fee, you can follow the steps earlier mentioned to calculate the amortization schedule.
To calculate the monthly payment, you can either use a calculator that allows you to input the loan amount, interest rate, and the repayment term or use an Excel spreadsheet to get the payment.
Formulas In An Amortization Schedule
To calculate the monthly principal that is due on an amortized loan, use the formula:
Principal Payment = Total Monthly Payment – [Outstanding Loan Balance x (Interest Rate / 12 Months)]
If the monthly payment is not specified, you can calculate using the formula:
Total Monthly Payment = Loan Amount [ i (1+i) ^ n / ((1+i) ^ n) – 1) ]
where:
- i = monthly interest rate. You’ll need to divide your annual interest rate by 12. For example, if your annual interest rate is 3%, your monthly interest rate will be 3% / 12 = 0.0025
- n = number of payments over the loan’s lifetime. Multiply the number of years in your loan term by 12. For example, a 4-year car loan would have 48 payments (4 years * 12 months)
Why An Amortization Schedule Can Be Helpful
The information in a loan amortization schedule is helpful in many ways. It helps you evaluate different loan options, decide whether to refinance an existing loan and calculate how much you will be saving by paying off your debts early. When you know the total amount of interest to pay over a loan’s lifetime, it can motivate you to make your principal payments early. Also, making extra payment that reduces outstanding principal will result in a reduced interest amount for future expenses.
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