What is an amortization table?
Whether you are buying a new car, funding your education or buying property, it’s essential to understand the terms of your loan. While understanding down payments and interest rates may seem difficult at first, it’s easy to keep track of your monthly repayments with an amortization schedule, which is a table showing repayment amounts and how much of each payment goes toward interest on the loan.
By reviewing an amortization table before agreeing to a loan, you can get a good picture of the monthly payments, how long it will take to pay off the loan, and the total cost of borrowing.
Amortization is the term for paying off a debt with regular installments on a fixed repayment schedule over a set amount of time. Lenders use amortization schedules for loans that have a fixed payoff date, such as mortgages.
Each entry in the amortization table is a single payment against the loan. These payments are broken down into the amount going toward paying the principal of the loan and the amount going toward interest. At the beginning of the loan’s term, when the remaining principal is still high, most of the monthly payments go toward the interest. As the principal decreases, the percentage of each payment going toward interest decreases, and the percentage going toward the principal increases.
Consider you are buying a home for $200,000. You are making a 20 percent down payment of $40,000 and need to take out a mortgage for $160,000. You want a 30-year mortgage (360 months) at 4 percent interest. Your estimated monthly payment would be $763.86, and the first lines of your amortization schedule would look like this:
You can use Bankrate’s amortization schedule calculator to determine how much of your monthly payment will go toward principal and interest. However, it’s not that hard to calculate your own schedule. Month after month, the payments are the same, but the amount going toward the principal increases. By the end of the 30-year term, you will have paid the loan in full and all the interest on it, which would be $114,991.21.
To work out the schedule, you need to know the following:
- The sum borrowed
- The loan term
- Your monthly payment
- The monthly interest rate (1/12 of the annual interest rate)
For the first month’s payment, multiply the balance of the loan by the monthly interest rate. The result is the amount of interest for the first month’s payment. Subtracting this amount from your monthly payment tells you how much of your first payment goes toward paying the balance of the loan. Subtract this principal payment from the loan balance to get the new loan balance for the second month, and then repeat the whole process for the life of the mortgage.
Understanding amortization tables makes it easier to evaluate a loan offer, as you can see how much the interest is going to cost. Before committing to a loan, consider your options carefully, and use an online amortization schedule calculator so that you know the numbers before signing on the dotted line.