Loan Amortization Facts

So many people today need help understanding loan amortization and what it is. Most of the time you hear the words "loan amortization" we apply it to loan amortization calculators, so let get the facts. Amortization is a means of paying out a predetermined sum of money which is the sum plus interest over a fixed period of time such as 15 or 30 years per say, so that the principal is completely eliminated by the end of the term. This would be trivial if interest weren't involved, since one could simply divide the principal amount into a certain number of payments and be done with it. The Key is to find the right payment amount, which includes some principal and some interest. The math is not rocket science, but is beyond the abilities of the simple hand held calculator. For the more interested, there's a mathematical presentation of the problem and its solution and that is the loan amortization calculator.

The loan amortization calculator presumes that each payment should all be of a equal amount, and that a payment consists of some amount for principal reduction and the interest calculated on the principal balance and including the principal part of the current loan amortization payment. Many mortgages companies have stated mortgages are calculated using this method. Loan amortization is used most often in mortgages mostly within the United States and in short-term loans as well. But the loan amortization calculators can also be used to figure out how long it would take to pay off credit card debts as well.

Here is a classic example of a mortgage loan amortization would look like lets say we have laid out the payment schedule that would be commensurate with a $100,000 30 year mortgage at a rate of interest of 7% per annum. The method of calculation seems to be misunderstood or at least "little understood". Let's examine just how the interest and principal reduction work.

The loan amortization math would be as follows making mortgage payment number 1 we can calculate the interest portion of our payment as follows: 7% x the mortgage balance before the payment is made, $100,000 = $7,000, divide that by 12 months and we end up with $583.33 interest. Next subtract that from our payment of $665.31 and there is $81.89 left. This is the portion that goes to reducing the mortgage balance.

Mortgage payment number 2 is the same except we need to use the balance after payment number 1 or $99,918.02 x 7% = $6,994.26 divided by 12 months = $582.86, subtract that from our mortgage payment and we have $82.45 to again reduce our mortgage balance.

This continues each month. The interest portion goes down and the principal reduction goes up. The final payment is always less than the others. The reason is that when the amortization calculation occurs there is almost always a fraction beyond cents (e.g. $665.3024952 is the actual calculation for our loan) and this is rounded up. This makes the last payment smaller than the others because of the miniscule additional principal reduction. Otherwise the final payment would be larger than the others and the loan, by definition.

Loan amortization common terms and definitions:

Loan Amortization Equal installments of a loan repayment.

Amortization schedule A time table for payment of loans. An amortization schedule shows how much of each payment as it is applied to interest and principal the remaining balance after each payment.

Amortization term The number of months required to amortize the loan.

Amortize
Repay a loan with regular payments with both principal and interest.

Loan amortization is the basics of most current mortgage calculations today.