Mortgage Lending Practices...
Amortized Loan
The amortized
loan requires
regular equal
payments during the
life of the loan, of
sufficient size and
number, to pay all
interest due on the
loan and reduce the
amount owed to zero
by the loan's
maturity date.
Figure A
shows a
6-year,
$1000 term
loan with
interest of
$90 due each
year of it's
life. At
the end of the sixth
year the entire
principal (the
amount owed) is due
in one lump payment
along with the final
interest payment. In
figure B, the same
$1,000 loan is fully
amortized by making
six equal annual
payments of $222.92.
From the borrower's
standpoint, $222.92
once each year is
easier to budget
than $90 for 5 years
and $1,090 in the
sixth year.
Furthermore, the
amortized loan shown
in Figure B actually
costs the borrower
less than the term
loan. The total
payments made under
the term loan are
$90 + $90 + $90 +
$90 + $90 + $1,090 =
$1,540. Amortizing
the same loan
requires total
payments of 6 X
$222.92 = $1,337.52.
The difference is
due to the fact that
under the amortized
loan the borrower
begins to pay back
part of the $1,000
principal with his
first payment. In
the first year, $90
of the $222.92
payment goes to
interest and the
remaining $132.92
reduces the
principal owed.
Thus, the borrower
starts the second
year owing only
$867.08. At 9%
interest per year,
the interest on
$867.08 is $78.04;
therefore, when the
borrower makes his
second payment of
$222.92, only $78.04
goes to interest.
The remaining
$144.88 is applied
to reduce the loan
balance, and the
borrower starts the
third year owing
$722.20.
Figure 1:2 charts
this repayment
program.
Notice that as
the loan balance is
reduced, the
interest that must
be paid is reduced,
thus allowing a
larger and larger
portion of each
successive payment
to be used to reduce
the loan balance. As
a result, the
balance owed drops
faster as the loan
becomes older; that
is, matures.
Amortized
Loan To Budget Mortgage
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