What Is the Definition of an Amortization Table?
When you pay off an interest-bearing loan, part of each payment goes toward the interest and the rest pays down the loan balance, or the principal. Paying the interest due and a fixed amount toward the principal would amount to unequal payments; as the principal goes down, so does the interest. An amortization table, or schedule, figures out a fixed payment that pays off the loan over a given period. As the loan is paid down, more and more of each payment switches from the interest column into the principal column. Generally, this is how loans are paid off.
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Interest
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The periodic interest rate tells you how much interest is due for that period. Most loans are paid down in monthly installments. Generally, the periodic interest rate is the given, or nominal, yearly rate divided by 12. The actual annual rate will be less than the nominal rate in comparison to the loan balance at the beginning of the year. If you borrow $100 at 10% annually, you will not pay $10 if you make monthly installments that pay down the loan balance. The opposite is true when you save money in a bank and accrue compound interest. Here the annual rate is more than the nominal rate because the interest is added to the savings each time.
Formulas
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The formula for compounding interest over any amount of periods is one plus the periodic rate to the power of periods. We'll call the answer solution A. Solution A times the investment is what you come home with. Solution A minus one is the overall compounded rate. Call this solution B. The amortization formula uses the formula above. It is this: Multiply solution A by the periodic rate. Then divide that by solution B. Then multiply that by the original loan amount. The answer is your fixed periodic payment.
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PMT
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Excel has a quick way to find the fixed monthly payment. The PMT (payment) formula asks you to enter the periodic rate (called rate), the number of periods (nper) and the present value (pv). The present value is the loan amount. (To get a positive result, enter pv as a negative number.) Excel does the computation for you. Multiply by 12 to get the yearly payment. Divide the yearly payment by the loan amount to get your loan constant rate. The longer a loan is amortized over, the lower the periodic payment and loan constant.
Term Vs. Amortization
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The loan's term, the amount of time the lender will allow you to pay it off, and the amortization period do not have to be the same. If the lender allows you to pay off the loan according to the amortization schedule, then the two are the same. This is called a self-amortized loan. Otherwise, the lender will allow you to make smaller payments based on the longer schedule, but will nonetheless call the loan after the shorter term. You can then either pay off the balance, known as a balloon payment, or refinance. This is very common with commercial loans.
Amortization Table
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The complete amortization table lists each periodic payment and its ramifications. It lists the payment number, payment amount, interest amount, principal amount and loan balance. The interest amount is figured by multiplying the previous loan balance by the periodic interest rate. The principal amount is figured by subtracting the interest amount from the payment amount. The loan balance is figured by subtracting the principal amount from the previous loan balance.
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References
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