Amortizing loan is described as a loan that is paid on monthly installment basis. With amortized loan, the borrower set a schedule and period to make payments on both the principal and interest. The interest charge is paid off first within that period, then the remaining amount is worked towards reducing the principal amount.
It is considered that, while the interest charge payments for an amortization loan decreases, the principal amount increases.
Amortization schedule is determined as the situation at which the interest decreases. It shows the exact amount one pays each month towards the interest and what goes into reduction the principal.
The amortization system is different that one has borrower has to first pay part of the interest charge on the loan before aiming towards reducing the principal amount.
Types of Amortizing Loan
Most Loans that are paid on installation basis are considered as amortised loan. Below are the types of amortisation loan;
When someone borrows money to finance the purchase of a car or vehicle, it is termed as an auto loan. The type of loan are used to buy either new or used cars which will attract an interest charge. Payment of auto loans is done on monthly installment basis.
Cars buyers have the opportunity to chose between two options when it’s comes to auto loans. First, you can apply from a bank or lender who will take into consideration certain requirements and eligibility.
Secondly, you can apply from a car dealership who tends to sell the car for you on credit with the knowledge of paying on monthly installation basis.
This form of loan is also recognized as an amortized loan due to its payment system. Student loan repayment is done on monthly installment basis. Student loans are provided by the federal government in the US to students who finance their education. Under this student loan, there are four different types;
- Direct subsidized loans are available to undergraduate students with need financial support to cover the cost of their education.
- Direct Unsubsidized Loans are not provided based on financial need of the student but rather the school decides the amount you can borrow. Both Undergraduate and graduate students can seek for this loan.
- Direct PLUS loans are for certain category of people such as graduate or professional students, known as the Grad PLUS loan, or parents of dependent undergraduate students, known as the Parent PLUS loan.
- A direct consolidation loan is a type of loan that borrower has the opportunity to put together numerousfederal loans into one loan with a fixed interest rate.
With home loans, lender provide a borrower the opportunity to borrow money to by a house, apartment or property. It is also termed as a mortgage loan where the payment will be spread across several years or 10, 15 or 30 years.
Personal loans are also another form of amortised loans because the borrower gets a loan from a bank or credit union and make payment on monthly basis with interest.
How to calculate interest owed on an amortizing loan
Every loan attracts an interest that will be paid in addition to the principal amount. To know the interest you are supposed to pay of this kind of loan, the lender will multiple the the interest rate by the current loan. Then, the current amount will be divided by the number of months and added to interest to arrive at the monthly payment that will be made towards reduction the principal amount.
In calculating the interest owed by a borrower, the lender takes the current loan balance and multiple it by the given interest rate.
You are borrowed a $10,000 loan and have agreed to pay in 12 months at an interest rate of 2%. Your first payment will be $1200 as calculated below
$10,000 x 0.02 = $200
$10,000/10 months = $1,000
$200 + $1000 = $1,200 (first month payment)
After the first payment, the reminding balance of the loan will be $9000.
$9,000 x 0.02 = $180
$10,000/10 months = $1,000
$1000 + $180 = $1,180 (second payment)
Remaining balance will be $8,000.
$8,000 x 0.02 = $160
$10000/10 = $1,000
$1,000 + $160 = $1,160 (third payment)
It follows this trend till payment is made within the 10 months.
From the example above, you could notice that while the interest decreases ($200, $180, $160…..), the principal amount on the loan balance ($10,000) is consistent ($1,000), which means it’s not reducing.
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