Loan Amortization

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Loan Amortization

• Shad Valley

K. Hartviksen
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Blended Interest and Principal Loan Payments

• There are a number of alternative approaches that
  may be used to repay a loan.
• One of the most common is a fixed payment, fixed
  term loan where each payment covers the
  accumulated interest plus enough of the principal
  so that over the amortization period of the loan,
  the principal is retired.
• The formula for such a loan is found on the next
  slide

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Blended Interest and Principal Loan Payments -
formula
Where Pmt the fixed periodic payment t the
amortization period of the loan r the rate of
interest on the loan
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Blended Interest and Principal Loan Payments -
example
Where Pmt unknown t 20 years r 8
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Blended Interest and Principal Loan Payments -
example
Where Pmt unknown t 20 years r 8
This assumes you make annual payments on this
loanmost financial institutions want to see
monthly payments.
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Loan Amortization Tables

• It is often useful to break down the loan payment
  into its constituent parts.

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How are Loan Amortization Tables Used?

• To separate the loan repayments into their
  constituent components.
• Each level payment is made of interest plus a
  repayment of principal outstanding on the loan.
• This is important to do when the loan has been
  taken out for the purposes of earning taxable
  incomeas a result, the interest is a
  tax-deductible expense.

K. Hartviksen
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Loan Amortization Tables
K. Hartviksen
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Loan Amortization Example
In the third year, 800 of interest is paid.
Total interest over the life of the loan 2,400
1,600 800 4,800
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Example

• You have negotiated a mortgage loan on a new
  home. The total purchase price of the home is
  245,000 and you have a down payment of 45,000.
  (The 45,000 has come as a loan from your RRSP
  under the new Home Buyers Plan.) Your bank has
  given you the mortgage at a rate of 3.99 APR,
  but you know that the rate is compounded
  semi-annually. The mortgage payments will be
  amortized over 20 years.
• Determine the monthly mortgage payments on the
  loan.

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Example continued
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Example