Understanding Amortization of Loans

Overview of Amortization

• Amortization refers to the process of spreading payments over time, with each payment including both principal and interest.
• Amortization tables and calculators help determine the required monthly payments to fully pay off a loan by the last payment.

Key Concepts

• Principal: The original loan amount.
• Interest: The cost of borrowing, calculated on the outstanding balance.

Example Loan Scenario

• Loan Amount: $100,000
• Interest Rate: 6% per year
• Loan Term: 30 years
• Monthly Payment: $599.55

Breakdown of Monthly Payments

1. First Payment:

   • Loan Balance: $100,000
   • Interest (6% annual = 0.5% monthly):
     • 0.5% of $100,000 = $500
   • Principal Payment:
     • $599.55 - $500 = $99.55
   • New Loan Balance:
     • $100,000 - $99.55 = $99,900.45

2. Second Payment:

   • Loan Balance: $99,900.45
   • Interest:
     • 0.5% of $99,900.45 = $499.50
   • Principal Payment:
     • $599.55 - $499.50 = $100.05
   • New Loan Balance:
     • $99,900.45 - $100.05 = $99,800.40

3. Third Payment:

   • Loan Balance: $99,800.40
   • Interest:
     • 0.5% of $99,800.40 = $499
   • Principal Payment:
     • $599.55 - $499 = $100.54
   • New Loan Balance:
     • $99,800.40 - $100.54 = $99,699.86

4. Final Payment (360th Payment):

   • Loan Balance: $596.57
   • Interest:
     • 0.5% of $596.57 = $2.98
   • Principal Payment:
     • $596.57 - $2.98 = $593.59
   • Total Paid Off:
     • Principal reduces to $0 on the last payment.

Conclusion

• Payments contain both principal and interest, with the interest amount decreasing over time as the principal balance is paid down.
• Understanding this amortization process helps borrowers comprehend their loan structure and payments.

End of lecture.