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Amortization
Amortization

ofLoans
Loans
of

Chapter
14

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of

Amortization
Amortization

ofLoans
Loans
of

14 - 2

Learning Objectives

After completing this chapter, you will be able to:

Calculate
LO 1.
1.
LO

the principal balance after any payment

using both the Prospective
Method
and the Retrospective
Method

LO 2.
2.
LO

the final loan payment when it differs

from the others

LO3.3.
LO

the principal and interest components of

any payment

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And
And

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Amortization

ofLoans
Loans
of

14 - 3

Learning Objectives
Calculate

LO 4.
4.
LO

LO 5.
5.
LO

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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
Amortization

ofLoans
Loans
of

LO 1.
1.
LO

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.
1.

PMT =

12

9
0

240

-179.95
20 000

2. &
& 3.
3.
2.
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Amortization
Amortization

ofLoans
Loans
of

2.
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.
3.

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Thedifference
differenceofof$0.5345
$0.5345isisdue
duetotorounding
roundingthe
the
The
monthlypayment
paymenttotothe
thenearest
nearestcent!
cent!
monthly

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Amortization
Amortization

ofLoans
Loans
of

A $20,000 mortgage loan at 9% compounded

monthly requires monthly payments during its
20-year amortization period.
Calculatethe
theexact
exactbalance
balanceafter
after55years
years
Calculate
assumingthe
thefinal
finalpayment
paymentwill
willbe
beadjusted
adjustedfor
for
assuming
theeffect
effectof
ofrounding
roundingthe
theregular
regularpayment.
payment.
the
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
Amortization

ofLoans
Loans
of

A $20,000 mortgage loan at 9% compounded

monthly requires monthly payments during its
20-year amortization period.
Calculatethe
theexact
exactbalance
balanceafter
after55years
years
Calculate
assumingthe
thefinal
finalpayment
paymentwill
willbe
beadjusted
adjustedfor
for
assuming
theeffect
effectof
ofrounding
roundingthe
theregular
regularpayment.
payment.
the
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
Amortization

ofLoans
Loans
of

Considerthat
that
Consider
An Original Loan =

The PV of ALL of the Payments

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

Also,that
that
Also,
A Balance =

The PV of the remaining Payments

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

Then
Then
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Amortization
Amortization

ofLoans
Loans
of

this can
can be
be expressed
expressed as
as the
the Statement
Statement of
of Economic
Economic Equivalence
Equivalence
this

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

(Original Loan)

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PV of first x
Payments

PV of the
Balance just
after the xth
Payment

FocalDate
Date
Focal

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Amortization

14 - 10

Retrospective
Retrospective

Retrospective Method for Loan Balances

ofLoans
Loans
of

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

Thisisisnow
nowrearranged
rearrangedto
toisolate
isolatethe
theBalance
Balance
This
Balance

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FV of the
Original Loan

FV of the
Payments
already made

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Amortization
Amortization

ofLoans
Loans
of

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!`

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Application
Application

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Amortization
Amortization

ofLoans
Loans
of

A $20,000 mortgage loan at 9% compounded

monthly requires monthly payments of $179.95
during its 20-year amortization period.
Calculatethe
theexact
exactbalance
balanceafter
after55years.
years.
Calculate

Solve using
Retrospective Method
Prospective Method

Then compare
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Amortization
Amortization

ofLoans
Loans
of

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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.
Calculatethe
theexact
exactbalance
balanceafter
after55years.
years.
Calculate
12**55Years
Years
12

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

FV= 17,741.05

12

179.95
20,000
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Amortization

ofLoans
Loans
of

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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.
Calculatethe
theexact
exactbalance
balanceafter
after55years.
years.
Calculate

Total payments = 12*

12*20
20Years
Years==240
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

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Loans
of

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Comparison of Methods

Retrospective Method
Method
Retrospective
forLoan
Loan Balances
Balances
for

FV= 17,741.05

Prospective Method
Method
Prospective
for Loan
Loan Balances
Balances
for

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
Amortization

ofLoans
Loans
of

LO 2.
2.
LO

14 - 16

A $20,000 mortgage loan at 9% compounded

monthly requires monthly payments of $179.95
during its 20-year amortization period.
Calculatethe
thesize
sizeof
ofthe
thefinal
finalpayment.
payment.
Calculate

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
$176.74
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- 175.42

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Amortization
Amortization

ofLoans
Loans
of

A.
4

Meditech Laboratories
Laboratories borrowed
borrowed $28,000
$28,000 at
at
Meditech
10%, compounded
compounded quarterly,
quarterly,
10%,
to purchase
purchase new
new testing
testing equipment.
equipment.
to
Payments of
of $1,500
$1,500 are
are made
made every
every 33 months.
months.
Payments
A. Calculate
Calculate the
the balance
balance after
after the
the 10th
10th payment.
payment.
A.
B. Calculate
Calculate the
the final
final payment.
payment.
B.
Balance after 10 payments =
FV of $28,000 after 10 quarters FV of 10 payments

FV= - 19,037.29
1500
28,000

B.
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10

1.1. 2.2. 3.3.

Balance after
after
Balance
10 payments
payments
10

10

Needed

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Amortization
Amortization

ofLoans
Loans
of

Meditech Laboratories
Laboratories borrowed
borrowed $28,000
$28,000 at
at
Meditech
10%, compounded
compounded quarterly,
quarterly,
10%,
to purchase
purchase new
new testing
testing equipment.
equipment.
to
Payments of
of $1,500
$1,500 are
are made
made every
every 33 months.
months.
Payments
A. Calculate
Calculate the
the balance
balance after
after the
the 10th
10th payment.
payment.
A.
B. Calculate the final payment.

N ==
FV

-673.79
25.457

1.1. Calculate the number of payments

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

25
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3.3.

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Amortization
Amortization

ofLoans
Loans
of

Meditech Laboratories
Laboratories borrowed
borrowed $28,000
$28,000 at
at
Meditech
10%, compounded
compounded quarterly,
quarterly,
10%,
to purchase
purchase new
new testing
testing equipment.
equipment.
to
Payments of
of $1,500
$1,500 are
are made
made every
every 33 months.
months.
Payments
A. Calculate
Calculate the
the balance
balance after
after the
the 10th
10th payment.
payment.
A.
B. Calculate
Calculate the
the final
final payment.
payment.
B.

3.3. Calculate the final payment

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

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Amortization
Amortization

ofLoans
Loans
of

LO3.3.
LO

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
Amortization

ofLoans
Loans
of

14 - 21

A$9,500
$9,500 personal
personal loan
loan at
at 10.5%
10.5% compounded
compounded
A
monthly isis to
to be
be repaid
repaid over
overaa 4-year
4-yearterm
term
monthly
by equal
equal monthly
monthly payments.
payments.
by
A. Calculate
Calculate the
the interest
interest and
and principal
principal components
components
A.
of the
the 29th
29th payment.
payment. B.
B. How
How much
much interest
interest will
will
of
be paid
paid in
in the
the second
second year
year of
of the
the loan?
loan?
be
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
0

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Amortization

ofLoans
Loans
of

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A$9,500
$9,500 personal
personal loan
loan at
at 10.5%
10.5% compounded
compounded
A
monthly isis to
to be
be repaid
repaid over
overaa 4-year
4-yearterm
term
monthly
by equal
equal monthly
monthly payments.
payments.
by
A. Calculate
Calculate the
the interest
interest and
and principal
principal components
components
A.
of the
the 29th
29th payment.
payment.
of
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
==$204.34
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14 - 23

Amortization
Amortization

A$9,500
$9,500 personal
personal loan
loan at
at 10.5%
10.5% compounded
compounded
A
ofLoans
Loans
monthly isis to
to be
be repaid
repaid over
overaa 4-year
4-yearterm
term
of
monthly
by equal
equal monthly
monthly payments.
payments.
by
B. How
How much
much interest
interest will
will be
be paid
paid in
in the
the
B.
second year
year of
of the
the loan?
loan?
second
First: find the balance after 1 Year, and the balance after 2 Years

B.
12

FV = -5244.84
-7483.53

Balance
Balance
after
after2211years
years
year
after
year

24

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

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

ofLoans
Loans
of

This completes Chapter 14

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14 - 24