Definition
An amortization schedule is a detailed table of periodic payments made on a loan. It shows the breakdown of each payment towards principal and interest over the life of the loan. Additionally, it displays the remaining balance after each payment is made.
Phonetic
The phonetics of the keyword “Amortization Schedule” is: /əˌmɔːrtɪˈzeɪʃən ˈʃɛdjuːl/
Key Takeaways
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- An Amortization Schedule is a complete table of periodic loan payments, showing the amount of principal and the amount of interest that constitutes each payment until the loan is fully paid off at the end of its term.
- While each periodic payment is identical, in the beginning, the majority of each payment is devoted to interest but towards the end of the amortization schedule, the bulk of each payment covers the loan’s principal.
- The last line of the schedule shows the borrower’s total interest and principal payments for the entire loan term. With this, the borrower gets a clear picture of how much they are paying for their loan in total (sum of principal and interest), thus making it easier to make buying or refinancing decisions.
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Importance
The term Amortization Schedule is essential in business and finance as it offers a complete table of periodic loan payments, showcasing the amount of principal and the amount of interest that make up each payment until the loan is fully paid off at the end of its term. This allows borrowers and lenders to see the exact distribution of loan payments over the course of the loan’s lifespan, including how much of each payment is going towards interest versus how much is going towards paying down the principal. Hence, it provides a clear picture of the loan’s progress at any point in time which enhances financial planning, budgeting, and decision-making.
Explanation
The purpose of an amortization schedule is to provide a detailed breakdown of a loan’s repayment timeline. It offers a transparent roadmap displaying how the loan’s payments are divided into two significant parts: principal and interest. This schedule provides significant information to borrowers as it allows them to understand how much of every payment they make is allocated to clearing the debt’s principal (the original amount borrowed) and how much goes towards paying off the interest accrued at the loan’s agreed-upon rate.This information is particularly helpful in assessing the true cost of a loan over its lifetime. By offering a clear snapshot of how much will be paid towards interest as opposed to the loan’s principal amount, it allows borrowers to be savvy about their debt management decisions. Furthermore, it also provides information about the loan balance after each payment, and at any point in time during the term of the loan, a borrower can refer to the amortization schedule to find out the exact outstanding balance. This is extremely beneficial in planning prepayments or evaluating refinancing options.
Examples
1. Home Mortgage: A common real world example of an amortization schedule is a 30 year fixed rate home mortgage. A home buyer borrows a specific amount of money from a bank to purchase a house and pays it back in equal monthly payments over 30 years. The amortization schedule of this loan starts with a higher proportion of each payment going toward interest and gradually shifts to pay down more principal over time. 2. Student Loans: Another instance when you would use an amortization schedule is for a student loan. Let’s say a student borrows $20,000 to fund their education at a fixed interest rate of 5% with a repayment period of 10 years. The amortization schedule in this case would detail how much of each monthly payment goes toward the principal and interest.3. Car Loan: Car loans also use an amortization schedule. Suppose someone takes out a $15,000 loan at a 3% interest rate to buy a car, to be repaid over 5 years. The amortization schedule breaks down each monthly payment into principal and interest parts to show how each payment affects the loan balance, and to determine the total amount of interest paid over the life of the loan.
Frequently Asked Questions(FAQ)
What is an amortization schedule in finance?
An amortization schedule is a detailed table that displays the breakdown of each periodic payment on an amortizable loan. It lists the portion of each payment going towards interest and the portion going to the principal until the loan is paid off at the end of its term.
What information is included in an amortization schedule?
An amortization schedule typically includes information such as the date of each payment, the amount of each payment, the portion of each payment that goes towards the principal, the portion that goes towards interest, the total amount of interest paid so far, and the remaining loan balance after each payment.
How is an amortization schedule used?
An amortization schedule is used to understand the allocation of your loan payments over time, showing how much of your payments are going towards paying off interest versus reducing the principal amount. It can be used to track the progress of your loan repayment and to plan your future payments.
How is an amortization schedule calculated?
An amortization schedule is calculated using the principal loan amount, annual interest rate, loan term, and payment frequency. The calculation involves determining how much of each payment goes towards interest and how much goes towards reducing the principal.
Is an amortization schedule the same for all types of loans?
No, an amortization schedule can differ depending on the type of loan. For instance, a mortgage loan typically uses an amortization schedule where the payments are split into principal and interest amounts, while an interest-only loan has payments that only cover interest for a set period.
Can an amortization schedule change over time?
Usually, an amortization schedule does not change, assuming a fixed interest rate and fixed payment amount for the life of the loan. However, if there are extra principal payments, refinancing, or if the interest rate is variable, the schedule can change.
Can I create my own amortization schedule?
Yes, you can create your own amortization schedule. Many financial websites and calculators can help you create an amortization schedule, and various types of software such as Microsoft Excel have functions and templates for this purpose.
Related Finance Terms
- Principal Amount
- Interest Rate
- Loan Term
- Payment Frequency
- Outstanding Balance
Sources for More Information
