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Amortization

of Loans

Chapter
14

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of

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Amortization

Learning Objectives

of Loans

After completing this chapter, you will be able to:

Calculate
LO 1.

the principal balance after any payment

using both the Prospective Method
and the Retrospective Method

LO 2.

the final loan payment when it differs

from the others

LO 3.

the principal and interest components of

any payment

And
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Amortization

of Loans

Learning Objectives
Calculate

LO 4.

LO 5.

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mortgage payments for the initial loan

and its renewals
mortgage loan balances and
amortization periods to reflect
prepayments of principal

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Amortization

of Loans

LO 1.

A $20,000 mortgage loan at 9% compounded

monthly requires monthly payments during its
20-year amortization period.
(1) Calculate the monthly payment.
(2) Using the monthly payment from part (1),
calculate the PV of all payments.
(3) Why does the answer in (2) differ from $20,000?
PV = $20000

FV = 0 n =12* 20 = 240

1.
PMT =

12

240

-179.95

20 000

2. & 3.
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Amortization

of Loans

2.

(2) Using the monthly payment from part (1),

calculate the PV of all payments.
(3) Why does the answer in (2) differ
from $20,000?
PV = ?

FV = 0

n =12*20 = 240

PMT = 179.95

179.95
PV = 20,000.5345
179.95

3.

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The difference of $0.5345 is due to rounding the

monthly payment to the nearest cent!

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Amortization

of Loans

A $20,000 mortgage loan at 9% compounded

monthly requires monthly payments during its
20-year amortization period.
Calculate the exact balance after 5 years
assuming the final payment will be adjusted for
the effect of rounding the regular payment.
Calculate the exact n for monthly payments of
$179.95 to repay a $20,000 loan...

20 000
N=

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239.982

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Amortization

of Loans

A $20,000 mortgage loan at 9% compounded

monthly requires monthly payments during its
20-year amortization period.
Calculate the exact balance after 5 years
assuming the final payment will be adjusted for
the effect of rounding the regular payment.

N = = 17,741.05
P/V
179.9821
239.982
After 5 years, 239.982 60 = 179.982 payments remain.
Therefore, balance (after 5 years)
= PV of 179.982 payments of $179.95
60
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Amortization

of Loans

Consider that
An Original Loan =

The PV of ALL of the Payments

(discounted at the contractual
rate of interest on the loan)

Also, that
A Balance =

The PV of the remaining Payments

(discounted at the contractual
rate of interest on the loan)

Then
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Amortization

of Loans

this can be expressed as the Statement of Economic Equivalence

For a focal date of the original date of the loan,

(Original Loan)

PV of first x
Payments

PV of the
Balance just
after the xth
Payment

Focal Date
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Amortization

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Retrospective
Retrospective

of Loans

Retrospective Method for Loan Balances

Suppose we locate the Focal Date of the xth payment,

the Statement of Economic Equivalence becomes

FV of the
Original Loan

FV of the
Payments
already made

Balance

This is now rearranged to isolate the Balance

Balance

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FV of the
Original Loan

FV of the
Payments
already made

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Amortization

of Loans

Prospective Method for Loan Balances

is based on PAYMENTS YET to be MADE!`

Retrospective
Retrospective

Retrospective Method for Loan Balances

is based on PAYMENTS ALREADY MADE!`

Application
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Amortization

of Loans

A $20,000 mortgage loan at 9% compounded

monthly requires monthly payments of $179.95
during its 20-year amortization period.
Calculate the exact balance after 5 years.

Solve using
Retrospective Method
Prospective Method

Then compare
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Amortization

of Loans

Retrospective Method for Loan Balances

A $20,000 mortgage loan at 9% compounded
monthly requires monthly payments of $179.95
during its 20-year amortization period.
Calculate the exact balance after 5 years.
12 * 5 Years

Balance = FV of $20,000 FV of first 60 payments

FV= 17,741.05

12

179.95
20,000
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60

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Amortization

of Loans

Prospective Method for Loan Balances

A $20,000 mortgage loan at 9% compounded
monthly requires monthly payments of $179.95
during its 20-year amortization period.
Calculate the exact balance after 5 years.

Total payments =

12* 20 Years = 240 - 60 made = 180 remaining

Balance = PV of remaining 180 payments

PV= 17,741.88

12

179.95
0
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180

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Amortization

of Loans

Comparison of Methods

Retrospective Method
for Loan Balances

FV= 17,741.05

Prospective Method for

Loan Balances

PV= 17,741.88

Difference ($0.83) is because the Prospective Method

assumes that the final payment is the same as all the others.
The Retrospective Method is based on payments
already made.
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Amortization

3
of Loans

LO 2.

A $20,000 mortgage loan at 9% compounded

monthly requires monthly payments of $179.95
during its 20-year amortization period.
Calculate the size of the final payment.

Final Payment = (1+i) * (Balance after 2nd to last payment)

Balance after 239 payments =
FV of $20,000 after 239 months FV of 239 payments

179.95
12

239

FV=

20,000
Final Payment = (1+0.09/12) * 175.42
= $176.74
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- 175.42

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Amortization

3
of Loans

A.
4

Meditech Laboratories borrowed $28,000 at

10%, compounded quarterly,
to purchase new testing equipment.
Payments of $1,500 are made every 3 months.
A. Calculate the balance after the 10th payment.
B. Calculate the final payment.
Balance after 10 payments =
FV of $28,000 after 10 quarters FV of 10 payments

FV= - 19,037.29
1500

10

Balance after
10 payments

10

28,000

B.
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1.

2.

3.

Needed

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Amortization

3
of Loans

Meditech Laboratories borrowed $28,000 at

10%, compounded quarterly,
to purchase new testing equipment.
Payments of $1,500 are made every 3 months.
A. Calculate the balance after the 10th payment.
B. Calculate the final payment.

N ==
FV

-673.79
25.457

1. Calculate the number of payments

0
2. Calculate the balance after the 2nd to last payment

25
3.
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Amortization

3
of Loans

Meditech Laboratories borrowed $28,000 at

10%, compounded quarterly,
to purchase new testing equipment.
Payments of $1,500 are made every 3 months.
A. Calculate the balance after the 10th payment.
B. Calculate the final payment.

3. Calculate the final payment

Final Payment = (1+0.10/4) * 673.79
= $690.63

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Amortization

of Loans

LO 3.

A $9,500 personal loan at 10.5%

compounded monthly is to be
repaid over a 4-year term by
equal monthly payments.

A. Calculate the interest and principal

components of the 29th payment.
B. How much interest will be paid in
the second year of the loan?

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Amortization

3
of Loans

A $9,500 personal loan at 10.5% compounded

monthly is to be repaid over a 4-year term
by equal monthly payments.
A. Calculate the interest and principal components
of the 29th payment. B. How much interest will
be paid in the second year of the loan?
First: find the size of the monthly payment
PV = 9500
n = 12(4) = 48 i = .105/12

PMT = - 243.23
12

48

9500

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10.5

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Amortization

3
of Loans

A $9,500 personal loan at 10.5% compounded

monthly is to be repaid over a 4-year term
by equal monthly payments.
A. Calculate the interest and principal components
of the 29th payment.
First: find the balance after the 28 payments

A.
243.23

PMT
FV
= = -4445.06
- 243.23
28

Interest Component of Payment 29 = i * Balance after 28th payment

= 0.105/12* 4445.06
= $38.89
Principal Component = PMT Interest Component
= $243.23 - $38.89
= $204.34
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Amortization

3
of Loans

A $9,500 personal loan at 10.5% compounded

monthly is to be repaid over a 4-year term
by equal monthly payments.
B. How much interest will be paid in the
second year of the loan?

First: find the balance after 1 Year, and the balance after 2 Years

B.
12

FV = -5244.84
-7483.53

Balance
after
after 21 years
year

24

Total Principal paid in year 2 = $7,483.53 - $5,244.84

= $2,238.69
Total Interest paid in year 2 = 12($243.23) - $2,238.69
= $680.07
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Amortization

of Loans

This completes Chapter 14

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