What to know about amortizations schedules? Basically, these schedules show you how many payments you have made towards your loan or mortgage, the payment date, the number of times you need to pay, the amount due for the month, the balance of what is still owed, and a breakdown of principal and interest. While this may make sense to a degree, it is still in financial jargon, which many people struggle to understand. This is why a practical example is often easier to understand.
Understanding the Details on What to Know About Amortizations Schedules:
Let's say that you have borrowed $10,000, and your annual interest rate (AIR) is 12%, with a monthly payment of $350. You receive your loan on January 15th, and your first payment is February 15th. Before your next payment, the lender multiples the outstanding balance by the interest rate, which, in this example, would be $100. This means that, out of the $350 you pay, $250 goes towards your principal, reducing it to $9,750. If you were to miss a payment, however, your balance will increase. Let's say you didn't pay anything that first month, then the interest of $100 would be added to your balance, meaning that you now owe $10,100.
Your second payment is due on March 15th. You owe $9,750 (if you made your first payment), and you pay the agreed$350 towards it, which means $252.50 goes towards the principal, leaving you with $9,497.50 to pay, and so on. You can, if you wanted to, calculate this all manually, but this can become very complex because real loans are never as straightforward as the amounts given above, and it is all too easy to make a mistake.
What to know about amortizations schedules as well is that they are for your reference only, to give you an idea of what you owe, what you have paid, and what you still have to pay. One of the main reasons why you should not make these calculations manually is because of the final payment, which is likely to be more than what you still owe.
Sticking to the example used above. Once you have made six payments, you will still owe $8,462. At that point, your interest is $87.25, which means your balance drops by $262.75. You could, if you wanted to, make a balloon payment at that point of $350 and $8,462. If you did that, your loan would be paid off. However, most lenders then impose some sort of early redemption fee on you, because they make their money by charging you interest rates and, if you pay it off early, they will earn less than is acceptable to them. As a result, you are likely to have to pay a percentage of the outstanding interest payments – so not necessarily the principal value – in order to get out of your loan.
The construction above is the most commonly used in fixed rate mortgages with monthly payments. If you do not have a fixed rate mortgage, however, things become more complex again. This is because the interest rate will vary, potentially with each monthly payment you make.