Amortization

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Chapter
14 of
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Calculate
Learning Objectives
the principal balance after any payment
using both the Prospective Method
and the Retrospective Method
After completing this chapter, you will be able to:
the principal and interest components of
any payment
And
the final loan payment when it differs
from the others
LO 1.
LO 2.
LO 3.
Amortization


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Learning Objectives
Calculate
LO 4.
LO 5.
mortgage loan balances and
amortization periods to reflect
prepayments of principal
mortgage payments for the initial loan
and its renewals
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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?
240
9
0
20 000
PMT = -179.95
12
n =12* 20 = 240 PV = $20000 FV = 0
1.
2. & 3.
LO 1.
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(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?
2.
3.
179.95
179.95
n =12*20 = 240 PV = ? FV = 0 PMT = 179.95
PV = 20,000.5345
The difference of $0.5345 is due to rounding the
monthly payment to the nearest cent!
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Calculate the exact balance after 5 years
assuming the final payment will be adjusted for
the effect of rounding the regular payment.
A $20,000 mortgage loan at 9% compounded
monthly requires monthly payments during its
20-year amortization period.
Calculate the exact n for monthly payments of
$179.95 to repay a $20,000 loan...
20 000
N = 239.982
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Calculate the exact balance after 5 years
assuming the final payment will be adjusted for
the effect of rounding the regular payment.
A $20,000 mortgage loan at 9% compounded
monthly requires monthly payments during its
20-year amortization period.
After 5 years, 239.982 60 = 179.982 payments remain.
Therefore, balance (after 5 years)
= PV of 179.982 payments of $179.95
60
N = 239.982 N = 179.9821 P/V = 17,741.05
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An Original Loan =
Consider that
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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this can be expressed as the Statement of Economic Equivalence
(Original Loan)
Focal Date
PV of first x
Payments
PV of the
Balance just
after the xth
Payment
For a focal date of the original date of the loan,
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of the xth payment,
the Statement of Economic Equivalence becomes
Retrospective Method for Loan Balances
Retrospective
Retrospective
Suppose we locate the Focal Date
Balance
This is now rearranged to isolate the Balance
Balance
FV of the
Original Loan
FV of the
Payments
already made
FV of the
Original Loan
FV of the
Payments
already made
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Retrospective Method for Loan Balances
Retrospective
Retrospective
is based on PAYMENTS ALREADY MADE!`
Prospective Method for Loan Balances
is based on PAYMENTS YET to be MADE!`
Application
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Calculate the exact balance after 5 years.
A $20,000 mortgage loan at 9% compounded
monthly requires monthly payments of $179.95
during its 20-year amortization period.
Solve using
Retrospective Method
Prospective Method
Then compare
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Retrospective Method for Loan Balances
Calculate the exact balance after 5 years.
A $20,000 mortgage loan at 9% compounded
monthly requires monthly payments of $179.95
during its 20-year amortization period.
Balance = FV of $20,000 FV of first 60 payments
60 179.95
12
9
20,000
12 * 5 Years
FV= 17,741.05
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Prospective Method for Loan Balances
Calculate the exact balance after 5 years.
A $20,000 mortgage loan at 9% compounded
monthly requires monthly payments of $179.95
during its 20-year amortization period.
12* 20 Years = 240 Total payments =
180 179.95
12
9
PV= 17,741.88
0
- 60 made = 180 remaining
Balance = PV of remaining 180 payments
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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.
FV= 17,741.05
Retrospective Method
for Loan Balances
PV= 17,741.88
Prospective Method for
Loan Balances
Comparison of Methods
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Final Payment = (1+i) * (Balance after 2
nd
to last payment)
Balance after 239 payments =
FV of $20,000 after 239 months FV of 239 payments
239
179.95
12
9
FV= - 175.42
20,000
Final Payment = (1+0.09/12) * 175.42
= $176.74
Calculate the size of the final payment.
A $20,000 mortgage loan at 9% compounded
monthly requires monthly payments of $179.95
during its 20-year amortization period.
LO 2.
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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
10 1500
4
10
FV= - 19,037.29
28,000
A.
B.
2. 1. 3.
Needed
Balance after
10 payments
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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.

the number of payments 1. Calculate
0
N = 25.457 FV = -673.79
25
the balance after the 2
nd
to last payment
2.
Calculate
3.
B. Calculate the final payment.
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the final payment 3. Calculate
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.
Final Payment = (1+0.10/4) * 673.79
= $690.63
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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?
LO 3.
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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 = n = i =
9500
12(4) = 48 .105/12
48
12
10.5
PMT = - 243.23
9500 0
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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.
A.
First: find the balance after the 28 payments
28
PMT = - 243.23
243.23
FV = -4445.06
Interest Component of Payment 29
= 0.105/12* 4445.06
= $38.89
= i * Balance after 28th payment
Principal Component = PMT Interest Component
= $243.23 - $38.89
= $204.34
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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
12
FV = -7483.53
Total Principal paid in year 2 = $7,483.53 - $5,244.84
= $2,238.69
24
FV = -5244.84
Total Interest paid in year 2 = 12($243.23) - $2,238.69
= $680.07
Balance
after 1 year
Balance
after 2 years
B.
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This completes Chapter 14