Amortization schedule

Definition

An amortization schedule is a detailed table that outlines the repayment plan for a loan, showing the breakdown of each payment into principal and interest over the life of the loan. This schedule helps borrowers understand how much they will pay in total and how their balance decreases over time. It’s particularly important for loans like mortgages and auto loans, where payments are made regularly until the debt is fully repaid.

5 Must Know Facts For Your Next Test

1. An amortization schedule typically includes columns for payment number, payment amount, interest paid, principal paid, and remaining balance.
2. As payments are made over time, a greater portion of each payment goes towards reducing the principal, while less is allocated to interest.
3. For fixed-rate loans, the amortization schedule remains constant throughout the life of the loan, meaning the monthly payment does not change.
4. An amortization schedule can help borrowers see how long it will take to pay off their loan and how much interest they will pay over its entire term.
5. Adjustable-rate loans may have fluctuating payments based on changes in interest rates, which can complicate their amortization schedules.

Review Questions

• How does an amortization schedule help borrowers manage their loans effectively?
  • An amortization schedule provides borrowers with a clear view of each payment they make, detailing how much goes toward interest versus principal. This transparency allows borrowers to understand their financial commitment better and plan for future payments. By seeing how their balance decreases over time, they can also track their progress toward fully paying off the loan.
• In what ways can differences in loan terms affect the amortization schedule for a fixed-rate mortgage compared to an adjustable-rate mortgage?
  • A fixed-rate mortgage has a consistent amortization schedule since the interest rate remains unchanged throughout the loan term. This leads to predictable monthly payments. In contrast, an adjustable-rate mortgage may have variable interest rates that change at specified intervals. As rates change, so do the payment amounts and the structure of the amortization schedule, which can complicate financial planning for borrowers.
• Evaluate the impact of making extra payments on a loan in relation to its amortization schedule.
  • Making extra payments on a loan can significantly shorten its repayment period and reduce overall interest paid. When additional payments are applied to principal, it accelerates the decrease in remaining balance, thus altering the original amortization schedule. This can lead to substantial savings over time as less interest accrues on a smaller principal amount. Borrowers should check how their lender applies extra payments to ensure they benefit fully from these adjustments.

Related terms

Principal:

The original sum of money borrowed in a loan, or the amount still owed on a loan, excluding interest.

Interest Rate: The percentage of a loan charged as interest to the borrower, typically expressed as an annual percentage rate (APR).

Loan Term: The duration over which the borrower agrees to repay the loan, often expressed in months or years.