Most people that have taken out a loan of some sort have come across a loan amortization schedule. You would know it if you saw it, usually very large and filled with a bunch of numbers. So, what is it and how do you read it?
Lets start with what is it. A loan amortization schedule is simply a detailed view of how your loan will be repaid. Lets take a very simple example; say you borrow $75 interest free from a friend and you agree to repay the loan back with three $25 monthly payments. Your loan Amortization schedule would simply be three lines long. Line one would show $75 less $25 payment = $50 Balance. Line two would be $50 less $25 payment = $25 Balance, and line three would be $25 – $25 payment = $0 balance. Each line represents one month.
That is it. Off course they are not all that simple but the concept is basically the same with any loan amortization schedule. Lets say for example you have a 30 year fixed loan with a 5% interest rate. Your amortization schedule is going to be 360 lines long and contain on each line the beginning balance, applied interest, applied principle, your scheduled payment, and the new balance.
So now you know what a loan amortization schedule is, how do you read one effectively? There are many useful ways, but the main key in reading a loan amortization schedule is remembering what each factor under the column headings mean. Here are the basic ones:
Starting Balance – On the first line of the loan amortization schedule is the agreed loan amount, thereafter it is the new balance after the application of the previous periods interest and payment adjustments also known as remaining balance.
Loan Payment – This is the fixed payment amount you need to make in order to pay the loan back in the time you are evaluating or agreed to.
Applied Principle – This is the actual amount of your payment that gets applied to the balance of your loan. Each payment you make is going to pay some portion to interest and some portion to principle. If you make a $100 payment and your loan amortization schedule says that $25 is applied to principle, it simply means that $75 pays for that month’s interest and you loan balance only decreases by $25. Disappointing I know, but that is the cost of a loan.
Applied Interest – Similarly to applied principle, this is the interest applied and paid for in the period you are looking at.
Those are the key factors in any loan amortization schedule. Some may have more or less factors depending on how complicated your loan is. The basic thing to remember is that the amortization schedule shows you the details of the repayment of your loan. If you have a 30 year mortgage you can use the amortization schedule to know exactly what your loan balance will be after 5, 10, or 20 years of consistent payments. This is extremely useful for any borrower to know as you can quickly tally up all the interest you will pay, determine the true cost of your loan, or see how the interest and principle are impacted by payments over time.
Once you understand the basics, you can extend your knowledge into more advance techniques such as figuring out how paying beyond the scheduled payment impacts your loan, or how making one extra payment on a 30 year mortgage significantly reduces the total interest you pay over the life of the loan, or figuring out the break even point on paying points on your loan. An amortization schedule is a powerful tool in helping you understand the components of your loan. Always remember that a lender should be able to provide an amortization schedule for you and if they can’t then run away because they are trying to give you something that is not what they are claiming. An amortization schedule can be created for any loan, even your credit cards. I encourage anyone with credit cards to create one to see just how much those credit cards are costing you. Many internet sites can create them for you with just the basic information. Have fun, and remember the more you know the less chance you have in getting a sour deal.