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Amortization is the gradual repayment of a debt over time.
There are many different ways you can repay a loan and many
different amortization methods. There three (3) most common
amortization methods involve fixed-rate, variable-rate and
interest-only loans. In an effort to keep things simple, we only
discuss here the above common amortization methods.
Fixed-rate
A
fixed-rate loan is when the borrower repays the loan in installments
at the same interest rate for each repayment period.
Let's say the borrower has a $1,000 loan that will be repaid weekly
over the course of a year at 6.50% nominal rate. The first few
payments would look like the following:
|
Number |
Date |
Days |
Payment |
Interest |
Principal |
Balance of Principal |
|
0 |
01/01 |
|
|
|
|
1,000 |
|
1 |
01/08 |
7 |
20.25 |
1.25 |
19.00 |
981.00 |
|
2 |
01/15 |
7 |
20.25 |
1.22 |
19.03 |
961.97 |
|
3 |
01/22 |
7 |
20.25 |
1.20 |
19.05 |
942.92 |
|
4 |
01/29 |
7 |
20.25 |
1.18 |
19.07 |
923.85 |
| ... |
|
|
|
|
|
|
Fixed-rate loans are common and easy to calculate. However, when I
personally shopped for a loan to purchase my first home, not one
lender would consider a fixed-rate loan. Interest rates were
raising and the bankers knew they going up. Every lender tried to
persuade me to sign up for a variable-rate loan.
Variable-rate
A
variable-rate loan is when the borrower repays the loan in
installments at an interest-rate that changes at least once during
the repayment of the loan. Generally the loans starts out a low,
very enticing interest rate and then after 1, 3, or 5 years (the
adjustment period), the rate changes to the prevailing interest
rate.
When
I shopped for a loan to purchase my first home, lender after lender
proposed 3-year variable rate loans to my wife and I. The initial
rate was lower than what I would have attained from a fixed-rate
loan!!!! However, after the adjustment period of three years, the
rate would then adjust to the prevailing market rate, which I knew
was going to be much higher.
Interest Only
A
mortgage is “interest only” if the monthly payment does not include
any repayment of principal for some period. The payment consists of
interest only.
At the end of the term, the initial loan balance is paid off in
one-lump sum. Examples of how to calculate interest-only loans by hand
are discussed
here.
Banks
want to make money via interest and fees; they also want to get the
loan signed. I have seen some exotic loans in my day that are
combinations of the above methods. Study the terms and conditions
carefully and shop around. Its free to shop!
Please call (608) 444-6575 or e-mail (info@powerofinterest.com)
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