What is an Amortization Schedule?
How Do I Calculate Amortization?
Every loan, be it a home mortgage or auto loan, has two parts: principal and interest. Amortization is the process of paying down the interest portion of you loan. When you examine your mortgage bills, you will notice that your monthly payments are the same every month, but the proportions devoted to principal and interest are different. At the beginning of the loan period, a larger percentage of your monthly payment goes toward interest than at the end of the period. This gradual decrease in the amount of interest owed is called amortization.
This article explains how amortization is calculated. If you have paper, pencil, and a calculator, you can compute an amortization schedule by hand. You can also make a spreadsheet in Excel, or use the Amortization Calculator above.
First, you need to know the principal of the loan P, the annual interest rate R, the number of months in the loan period N, and the monthly payments M. Use a mortgage calculator to compute M.
For simplicity, let's use an easy example to illustrate how amortization is computed. Suppose the principal is $1000, the annual interest rate 10%, and the loan length 12 months. Using a mortgage calculator, we find that the monthly payments are $87.92.
Next, make a table with five columns and enough rows for each month. The columns are: month number, monthly payment, interest portion, principal portion, and remaining principle balance. The interest portion and principal portion always add up to equal the monthly payment.
For the first month, the amount of interest you pay is (10/12)% of the loan amount, i.e., ($1000)(0.1)/12 = $8.33. The principal you pay is $87.92 - $8.33 = $79.59. And finally, the remaining principal is $1000 - $79.59 = $920.41.
For the second month, the amount of interest paid is (10/12)% of the remaining principal balance. Thus, ($920.41)(0.1)/12 = $7.67. The principal paid is $87.92 - $7.67 = $81.25. And finally, the remaining principal balance is $920.41 - $80.25 = $840.16.
Repeat this process until you fill out the whole table. Notice that the interest portion of your monthly payment decreases each month. For longer loan periods, your bank or lending institution will make minor adjustments due to rounding errors, so some months may be off by a few cents.
Knowing the amortization schedule is helpful in case you decide to refinance your mortgage down the line, since loans are refinanced according to the amount of principal balance due, not the interest due or the total amount paid.
Use the Amortization Calculator above generate the amortization schedule for any home mortgage or auto loan. simply input the the pricipal, interest rate (as a decimal) and number of months in the loan term. You can use the sample numbers above, or input different values.
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