Personal Finance: Loans and Loan Amortisation

At some point in your life, you will need a loan. Whether it’s for a new car, house, or something important, loans can help you buy the things that you need. And with loans, you will encounter loan amortisations. In this article, you learn how loan amortisation works to give you additional hints when you sign a loan in the future.

Amortisation is the spreading out the amount of loan and interest in multiple periods. It can be annual, semi-annual, quarterly, and monthly. In this article, you’ll learn how to make a basic amortisation table.

So when a lending company gives you an amortisation table, you’ll how it was prepared and how to read it.

For illustration purposes, here’s our sample situation: On January 1, Mr X signs a $35,000 loan with Y Money Lenders payable every month for five years. The interest rate of the loan is 12 per cent per annum. Payments would be at the end of each month.

Step 1: Determine the monthly payment

To compute the monthly payment, financial institutions use the present value of an ordinary annuity to calculate the amount of interest payment. The formula for the monthly payment would be:

Monthly Payment = Principal Amount
[ 1 – (1 + k)-n ] ÷ k

Understanding the formula will give you additional hints in grasping the concept of amortisation.

Procedure:

  • State the interest (k) every month or 1% (12% ÷ 12 months).
  • Compute the number of periods (n). In this case, the number of periods is 60 months (5 years x 12 months).
  • Substitute the amounts in the formulae. Use a scientific calculator to speed up the computation.
Monthly Payment = 35,000
[ 1 – (1 + 0.01)-60 ] ÷ 0.01

The monthly payment must be $778.55.

Step 2: Prepare the amortisation table

Your monthly payment of $778.55 composes of the interest for the month and the principal amortisation. If a lending company tells

The principal amortisation is the excess amount after interest. In a sheet of pad paper or through a spreadsheet, copy the proforma table below:

Date Monthly Payment

(MP)

Interest

Portion

(IP)

Principal Amortisation (PA) Remaining Principal

(RP)

(RP1)
(MP) (RP1) x (k) (MP) – (RP1) (RP2) = RP1–PA

The remaining principal decreases due to the principal amortisation. By the end of the loan term, the principal will be $0.

Date Monthly Payment Interest

Portion

Principal Amortisation Remaining Principal
Jan. 1 35,000.00
Jan. 31 778.55 350.00 428.55 34,571.45
Feb. 28 778.55 345.71 432.84 34,138.61
Mar. 31 778.55 341.39 437.16 33,701.45

If you’re using a spreadsheet, you can just drag down the amounts.

Analysis of the amortisation table

Look at the partial amortisation above. Do you notice anything? If yes, you must’ve seen that interest payments decrease and the principal amortisation increases. What could this mean?

In simple words, your interest payments decrease because you’re paying small portions of the principal over time. If you continue the table up to the sixtieth payment, you’ll see that the principal amortisation is more than the interest payment.

Now that you know how amortisation works talking to a lending company would give you additional hints on the payment schedule works. For lending services, visit lendingsolutionsgroup.com.au.