Loan Amortization

What is loan amortization? Loan amortization is the schedule of periodic payments for a loan and gives borrowers a
clear picture of what they’ll be repaying in each repayment cycle. You’ll have a fixed, consistent repayment schedule
over the entire period of your loan term.

Loans That Get Amortized

Amortization schedules are typically used for installment loans with known payoff dates, fixed interest rates and fixed
monthly payments, such as:

 Mortgage loan: Most conventional home loans are 15-year or 30-year terms with a fixed interest rate. Though
many homeowners may not keep their mortgage that long, such as if they sell their home or refinance, the
loan functions as if you are going to keep it for the entire 15-year or 30-year term.
 Car loan: Many car owners obtain an amortized auto loan for a term of five years or less. Some drivers decide
whether they can afford a car based on what their fixed monthly payment will be.
 Personal loan: A personal loan you can obtain from a credit union, bank or an online lender also tends to be
amortized. Typically, personal loans are given for a term of three years at a fixed interest rate with a fixed
monthly payment. Personal loans are generally used for debt consolidation or small personal projects.

You will pay these loans off with consistent payments until the balance is zero.

Loans That Don’t Get Amortized

Not every type of loan is amortized. The following are examples of loans that don’t get amortized:

 Credit card: A credit card, or revolving debt, is also not an amortizing loan. You can borrow on the card
repeatedly and choose how much you want to repay every month, as long as you make the minimum
payment. The payments are not fixed as they are with an amortized loan.

Composition of an Amortized Loan Payment

Payments for your loan go toward:

 Principal: This portion of your payment goes toward reducing the balance of your loan.
 Interest: This portion of your payment is what you pay your lender for loaning you money.

You make payments in regular installments of a set amount, though the ratio of interest to principal changes over the
repayment period. This change in the ratio of interest to principal is detailed further in a loan amortization schedule.

What Is an Amortization Schedule?

A table that shows periodic loan payments is referred to as an amortization schedule. You may also hear this referred
to as a mortgage amortization schedule or mortgage amortization table. This amortization schedule includes the
amount of principal and interest within each payment. Each monthly payment is listed to the end of the loan term,
when the loan will be paid off. Each payment is the same throughout the amortization schedule.
How Amortization Schedules Work

What is included in an amortization schedule?

 Interest costs: For every payment, a portion goes toward paying off interest. The interest of each payment is
calculated by multiplying the remaining balance of your loan by the interest rate.
 Principal repayment: After applying the interest charge, the rest of the payment goes toward paying down the
principal of the loan.
 Scheduled monthly payments: Each of your monthly payments is listed individually for the entire duration of
your loan.

The interest of a loan is calculated based on the loan’s most recent balance. When a payment exceeds the amount of
interest, this payment reduces the principal. The interest rate is then applied to this new principal balance, and
because the balance is lower, the amount of interest will also be lower. This is why the interest and principal in an
amortization schedule have an inverse relationship. As the portion of interest in a payment decreases, the portion of
principal in the payment increases.

The amortization schedule will generally contain seven columns:

 Month: This is simply a number that denotates each month of your repayment period.
 Beginning balance: This is the principal balance you have at the beginning of each new month before you
make a loan payment.
 Scheduled payment: This is your monthly loan payment. This number will be the same every month.
 Principal: This is the amount paid toward your principal with every payment. Each month, this number will
increase.
 Interest: This is the amount paid toward your interest with each payment. Every month, this number will
decrease.
 Ending balance: This is the balance of your loan after you make your monthly payment.
 Total interest: This column keeps track of how much you have paid toward interest so far. The final row will
show you how much interest you’ll pay in total over the duration of the loan. Your amortization table may or
may not include this cumulative

 The number of rows in your amortization table depends on the term of your loan. For example, if you have a
30-year mortgage, you’ll pay your loan off over the course of 360 months. This means your amortization table
will have 360 rows.
Alternatively, the columns of your amortization schedule may be each month of your loan term, while the
rows are your beginning balance, payment, principal, interest, ending balance and total interest.
When you calculate the amortization of your loan, you can create your own table with this information for the
duration of your loan.

How to Calculate Amortization

How do you calculate amortization? To create an amortization table, you have a few options:

 Use an online loan amortization calculator that will create the amortization schedule.
 Use a spreadsheet to create an amortization table and analyze your loan.
 Create an amortization table by hand.

If you want to set up your own amortization table, whether by hand or on a spreadsheet, you’ll need to know how to
perform the calculations.

To calculate the amortization of your loan, follow these steps:

 1. Calculate your monthly payment: This number will be the same every month.
2. Calculate your interest charge: To do this, multiply your beginning balance by your monthly interest rate. Your
interest charge will decrease every month.
3. Calculate your principal charge: To do this, subtract your interest charge from the monthly payment. This
number will show how much you’ll pay toward the principal that month.
4. Calculate your ending balance: To do this, subtract the beginning balance by the amount of principal paid that
month. This number will be your ending balance for that month.
5. Repeat steps 2 to 4: Use the ending balance from step 4 as your beginning balance for the next month.

1. Calculate Your Monthly Payment

To calculate your monthly payment, you’ll need to know the amount of your loan, the term of your loan and your
interest rate. These three factors will determine how much your monthly payment is and how much interest you’ll pay
on the loan in total.

If you lower the principal or interest rate of your loan, you’ll also lower your monthly payment and save money. You
can also lower your monthly payment by increasing the term of your loan, but you’ll ultimately pay more in interest.

You can calculate your monthly loan payments using this formula: M=P[r(1+r)^n/((1+r)^n)-1)]. If this formula seems
overwhelming, don’t worry. The calculation is actually pretty simple:

 M: This denotes your monthly mortgage payment.

 P: This denotes the principal amount of your loan. For example, if your loan is 100,000, this is the number you
would plug in for P.
 r: This denotes the monthly interest rate for your loan. The interest rate you’re given for your loan is an annual
rate, which means you’ll need to divide this number by 12, as there are 12 months in a year. This will give you
your monthly rate. For example, if your interest rate is 4.5%, your monthly rate is 0.045/12=0.00375.
 n: This denotes the total number of payments you’ll make on your loan. For example, a 30-year mortgage will
have 360 payments. You can calculate this number by multiplying the number of years for your loan term by
12, which is how many months there are in a year. 30×12=360.

For example, use the numbers above:

 Starting balance: 100,000

 Monthly interest rate: 0.00375
 Total number of payments: 360

M=100,000[0.00375(1+0.00375)^360/((1+0.00375)^360)-1)]

The monthly payment for a 100,000 mortgage at an annual interest rate of 4.5% for a 30-year term is 506.69.