What are ways for Determining Loan Amortisation Schedule?

What are amortized loans?

Most loans which are repaid in equal periodic installments (monthly, quarterly, or annually), which cover interest as well as principal repayment. These loans are referred to as “Amortized Loans.”

For an amortized loan, we would like to understand the following:

(a)the periodic instalment payment and,

(b)the loan amortization schedule showing the break-up of the periodic instalment payments between the interestcomponent and the principal repayment component.

What is a Loan Amortization Schedule?

A loan amortization schedule is a detailed table that breaks down each loan payment into two components: the amount that goes toward paying off the loan principal and the amount that covers the interest. This schedule spans the entire term of the loan, showing how the balance decreases over time until it reaches zero.

Key Components of an Amortization Schedule

1. Payment Number: The sequence number of the payment, indicating the payment period (e.g., Payment 1, Payment 2, etc.).
2. Payment Date: The date on which each payment is due.
3. Beginning Balance: The remaining principal balance of the loan at the beginning of the payment period.
4. Scheduled Payment: The total amount of the periodic payment. This amount usually remains constant for fixed-rate loans.
5. Principal Payment: The part of the payment that reduces the loan’s principal balance.
6. Interest Payment: The portion of the scheduled payment that covers the interest charged on the remaining loan balance.
7. Ending Balance: The remaining principal balance of the loan after the scheduled payment has been applied.
8. Cumulative Interest: The total amount of interest paid over the life of the loan up to that point.

An amortization schedule can be used to understand how much of each payment is going towards interest versus the principal, which is particularly useful for budgeting and financial planning.

 

How to Prepare Loan Amortization Schedule?

To see how these calculations work, let’s look at an example:

 A firm borrows Rs 1,000,000 at a 15% interest rate, to be repaid in 5 equal yearly instalments over the next 5 years.

Solution: The annual instalment payment A is obtained by solving the following equation.

Loan Amount= A * PVIFAnr (n=5, r=15%)

1,000,000= A* 3.3522

Hence A= 298,312

*PVIFAnr can be determined from PVIFA table.

LOAN AMORTIZATION SCHEDULE

Year	Beginning Amount (1)	Annual Instalment (2)	Interest (3)	Principal Repayment (2)-(3) = (4)	Remaining Balance (1)-(4)= (5)
1	1,000,000	2,98,312	150,000	148,312	851,688
2	851,688	2,98,312	127,753	170,559	681,129
3	681,129	2,98,312	102,169	196,143	484,986
4	484,986	2,98,312	72,748	225,564	259,422
5	259,422	2,98,312	38,913	259,399	23*

Note:* Due to rounding off error a small balance is shown

1) The interest component is the largest for Year 1 and progressively declines as the outstanding loan amount decreases.

2)Interest is calculated by multiplying the beginning loan balance by the interest rate.

3)Principal repayment is equal to annual instalment minus interest.

Importance of a Loan Amortization Schedule

1. Clarity and Transparency: It provides a clear understanding of how each payment is allocated, helping borrowers see how their loan balance decreases over time.
2. Financial Planning: By knowing the exact amount of principal and interest for each payment, borrowers can plan their finances more effectively.
3. Comparison of Loan Options: It allows borrowers to compare different loan options by illustrating how varying interest rates and terms affect the overall cost of the loan.
4. Prepayment Insights: Borrowers can see the impact of making additional payments towards the principal, which can reduce the total interest paid and shorten the loan term.

It is crucial to understand a loan amortization schedule for effective debt management. It offers a clear view of how payments are allocated, helps in financial planning, and provides insights into the overall cost of the loan. By familiarizing yourself with the components and interpretation of an amortization schedule, you can make more informed decisions about borrowing and repayment strategies.