An installment loan is the most common type of loan that a commercial bank will offer to a company that is looking to borrow money for business purposes. There are a number of different repayment schedules that can be utilized for installment loans; however, when it comes to repaying a loan for a business, the loan is often repaid either semi-annually or annually.
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The process of making these payments is referred to as loan amortization, and having a strong grasp of loan amortization is something that every owner of a business should strive to achieve.
What Is a Schedule of Amortization?
An amortization schedule is a complete table of periodic blended loan payments that shows the amount of principal and the amount of interest that compose each payment in order for the loan to be paid off at the end of its term. An amortization schedule is also known as an amortization table. Even though each periodic payment is the same, the majority of each periodic payment will be interest once you begin the repayment process.
As time goes on, a smaller portion of each payment is applied toward paying the interest on the loan, while a larger portion is applied toward paying off the debt. As the schedule progresses, a larger portion of each periodic payment will be applied toward principle. The total amount of interest and principle that the borrower will pay back over the course of the loan is detailed in the very last line of the amortization schedule. When this obligation is paid off in equal increments over the course of its term or life, it is referred to as being amortized.
How to Calculate the Amortization Plan of a Loan
If you already know how much the loan's monthly payment will be, producing an amortization schedule for the loan shouldn't be too difficult of a task for you. Multiply the whole amount of the loan by the interest rate on the loan beginning with the first month. To do this, take the total amount of the loan and multiply it by the interest rate. After that, to calculate your monthly interest payment for a loan with monthly payments, take the total amount and divide it by 12. When the interest is subtracted from the total monthly payment, the amount that is left over is the one that is applied to the principal. Proceed in the same manner for month two, with the exception that rather than beginning with the total amount of the loan, you should begin with the principal balance that was outstanding at the end of month one. Your loan principle ought to be paid off in full by the time the allotted term comes to an end.
Take the following as an example: Let's say you had a mortgage with a 30-year term, a balance of $240,000, an interest rate of 5%, and a payment of $1,288 each month on the loan. You would gain $12,000 for the first month if you took $240,000 and multiplied that number by 5%. If you were to divide that number by 12, the interest that would be due on your first monthly payment would be $1,000. The remaining $288 will go toward reducing the principle balance owed.
Your outstanding main balance as of the second month is $239,712, which is equal to $240,000 minus $288. If you multiply that by 5% and divide the result by 12, you will find that the amount that will go toward interest is slightly lower, coming in at $998.80. Your main balance will get smaller and smaller at an ever-increasing rate, while the amount of money that goes toward interest will gradually decrease over the course of the following months. By the 360th month, the total interest you owe drops to just $5, and the remaining $1,283 pays out the loan in its entirety.
When you are considering getting a loan, all you may know at first is how much money you want to borrow and the interest rate that will be attached to it. If this is the case, the first thing that needs to be done is to calculate how much the monthly payment will be. After that, you can compute the amortization schedule by following the methods that were given before.
There are a few approaches that can be taken to solve the problem. Using a calculator that allows you to input the amount of the loan, the interest rate, and the length of time it will take to pay it back is the simplest method. One example would be that our mortgage calculator will provide you with the monthly payment amount for a home loan. You can also use it to calculate payments for different kinds of loans by only altering the terms and excluding any estimations for the cost of maintaining a home or other property.
If you prefer to do things on your own, you can calculate the cost of the service by using a spreadsheet program like Excel. You can calculate the payment for the loan using the PMT function, which takes into account the interest rate, the total number of payments, and the principle balance. For instance, to determine the monthly payment for the illustration that was presented before, you may program a cell in Excel using the formula =PMT(5%/12,360,240000). You would end up with a total of $1,288 if you did so, as was demonstrated in that case.
Why a plan of amortization can be advantageous
A loan amortization schedule can be useful in various situations. A effective way to encourage early principal payments is to provide a clear estimate of the total interest you will pay over the life of the loan. Extra payments reduce the outstanding principal and, in turn, the interest you will pay in the future. This is why the impact of an extra dollar or two in payment may be so great.
To illustrate, let's use the first month of the preceding example and assume that instead of paying $1,288 you pay $1,488 toward principal. It's possible that you're imagining a $300 savings on your ultimate bill as a result. But even with the lower rate of interest, that extra $300 will prevent you from paying off the balance in full. If you invest $300 now, you will end up saving more than $1,300 in the long run.
It's tempting to put the loan amortization schedule your lender offers you in the "too hard" basket along with the other paperwork that needs your attention. However, an amortization schedule contains information vital to comprehending your loan. How a schedule is created is key information in determining its potential usefulness in helping you pay off debt as quickly as feasible.
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