A loan amortization schedule is a table showing how a loan repayment is done in equal installments over a specified period. In the beginning, the larger portion of your monthly repayment will go towards interest. With every repayment, your principal reduces. Hence, your interest portion will decrease and the principal repayment portion will increase every month.
What is an amortization schedule?
An amortization schedule is a table showing how a loan repayment is done in equal installments over a specified period. Also known as the loan amortization schedule, it shows the principal and interest portions for each repayment amount. Equated installments mean that every periodic payment will be of the same amount for the period of the loan.
In the early part of the repayment period, the major portion of every repayment amount consists of interest. This is because the loan principal outstanding during this period is large. Therefore, the interest calculated on this will also be more. As the principal gets repaid with every payment, the interest portion reduces, and the principal portion of the repayment amount increases. This is also how banks make money on the loan you take.
Formulae used in loan amortization calculation
Although calculations are not done manually today, the software that creates loan amortization schedules has certain formulae in-built. Otherwise, you will have to calculate the schedule all on your own.
You can easily create a loan amortization schedule without the help of software or an online amortization calculator if you know the total periodic payment, the tenure of your loan, the principal amount, and your rate of interest.
How to calculate total monthly payment
Your lender will usually inform you about the total amount you have to repay every month on your loan. But if you want to compare various loan options before you approach a lender, you can calculate the monthly payments on your own too. Here’s the formula for calculating the monthly loan repayment amount:
Total monthly payment amount = Loan amount x [ i (1+i) ^ n / ((1+i) ^ n) – 1)]
Here,
- i is the monthly rate of interest. To get this, simply divide your annual interest rate by 12. For example, if your annual rate is 5%, your monthly rate will be 5%/12 or 0.00417.
- n is the number of payments you have to make during the loan tenure or period. For example, if your loan is for a period of 10 years, multiply that by 12 to get the total number of payments. In this case, it will be 10 x 12 = 120.
Once you have the total monthly payment, you can calculate the principal and interest components as well.
How to calculate principal component
To calculate the principal amount payable, you can use the following formula:
Principal payment = Total monthly payment – [loan balance outstanding x (rate of interest/12)]
Let’s look at this with an example. Imagine you take a loan of $200,000 at an annual interest rate of 5% for a period of 20 years. Your monthly repayment amount will be $1,319.91. The monthly interest rate will be 0.05/12 or 0.00417. Multiplying this with the principal amount of $200,000, we get $833.33. If we subtract this from the 1st month’s repayment amount of $1,1319.91, we get $486.58 which is the principal amount repaid for the 1st month.
If you want to calculate the same for the 2nd month, simply subtract the repaid principal amount of $486.58 from the total outstanding principal of $200,000. We get $199,513.42. After this, simply repeat the method given above to get the interest and principal components for every subsequent month and create the loan amortization schedule. The repayment amount of $1,319.91 will remain the same. Only the principal and interest components will change.
Amortization schedule table
It’s easy to understand a loan amortization table once you understand how amortization works. With the examples given above, it is clear that with every monthly payment you make, your principal outstanding reduces.
Therefore, the interest portion also reduces with every repayment, and the amount paid towards the principal increases. This way, as you come to the end of the table, you will see that most of the repayment is going towards the principal.
Long or short amortization period – which is better?
Many borrowers face confusion as to what the duration of their amortization period should be. This depends entirely on how much you can afford to repay every month. Both the 30-year loan tenure as well as the 15-year loan period have their own advantages and drawbacks.
With a 30-year amortization period, your monthly payment amount will be lower but you will end up paying a lot more interest in the long term since your principal will remain outstanding for that long. With a 15-year amortization period, you will be able to repay the loan in half the time and you will not pay as much interest either. But your monthly repayment amount will be high.
So, the length of your amortization period should depend on how much you can afford to repay every month. If you can repay a higher amount, take the shorter period as you will complete repaying your loan soon. If not, choose the longer term.
