An amortization schedule is a periodic table of loan payments that shows the amount of principal and amount of interest of each payment until the loan is cleared at the end of its term. Initially, a larger percentage of each payment covers interest. Later in the schedule, most of each payment covers the loan's principal. Amortization tables help loan recipients understand how their loan payments break down and enable them to predict their outstanding balance or interest cost in the future.
Scheduled Payments
Since the amortization schedule is a periodic table, it shows every payment an investor makes. These payments are recorded systematically to ensure no confusion during the transactions. It also shows an investor the required monthly payments. Out of that payment, a share goes to the interest expense. The remaining share pays down the loan balance.
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Interest Expenses
Interest is charged on your loan each month (or another pre-determined period). When calculating the interest charge, the amortization table shows you where to multiply the remaining loan balance by your monthly interest rate. This is especially important with long-term loans. When looking for a loan, it is usually best to find one that requires interest payments in the early years (as opposed to one that boasts "interest-free for 24 months!").
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Principal Repayment
The monthly or per-period payments on a loan differ depending on the type of loan and the agreement signed beforehand. Interest will almost always take up a certain amount of the money you pay each month, but as the principal (the official loan amount before interest) is paid down, the interest rates will decrease, in most cases, as they are based on the remaining amount of the loan, not the total. You will see the loan balance decrease over time as you check through an amortization schedule.
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Cumulative Interest
Some amortization tables include the running totals that add up to the interest and payments over time. Any amortization schedule will show how much you are spending on interest with each payment. If you want to know the total interest charges over the first years, the amortization schedule can help. The table includes a column of “cumulative interest.” That is where the schedule records all the interest you pay over time (increasing with each payment, though by a lesser and lesser degree).
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Decision Making
The information from an amortization schedule makes it easier to weigh different loan options. Unfortunately, most borrowers never look at the amount of interest they pay. What they do is to focus on an affordable monthly payment. This decision does not take the big picture into account, and the individual can end up paying a lot more in the long run.
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The Cost of Borrowing
Once borrowers understand the loan components, it is easy to see how much interest they will pay, rather than solely focusing on the monthly payment. Most consumers make decisions based on cheap monthly payments. However, the interest costs are a better option when weighing the real cost of the purchase. In some cases, a lower monthly payment indicates more interest.
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Characteristics of Good Loans
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- Ensure all loan payouts occur at once. They should be lump-sum loans.
- Make sure the loan has a fixed interest rate.
- A loan should be paid down over time (amortization)
- Ideally, loan payments are made monthly.
Loans that meet these criteria include fixed-rate mortgages, personal loans, home equity loans, and most auto loans.
Other Types of Loans
Not all loans are amortized. This includes variable rate loans and lines of credit. These loans are harder to work with, but if you undertake careful calculation, you may find a good option. Credit cards are one example of a loan that is tricky to deal with. A consumer can borrow over and over again without paying off the initial "loan." Most credit cards don't meet the criteria noted earlier.
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Adjustable Rate Mortgages
An adjustable rate mortgage is a loan that determines the interest rate based on the current index. These are challenging to work out with an amortization schedule because the interest rate can fluctuate as the loan matures.
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How to Amortize Loans
You can acquire an amortization table in several ways. Find an online calculator that will automatically create a table for you, and enter the information into a spreadsheet, or build the table manually. There are many online resources that can help you figure out how much you are ultimately paying for your loan.
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