An amortization schedule is a table with the details of the amount of each payment allocated to principal and interest. Every payment made on a loan is split between principal and interest. An amortization schedule provides the exact amount remaining on a loan after each payment is made.
Amortization schedules are used in financial institutes to determine the amount outstanding on a loan at any point in time. The schedules are created for ease of use, but the actual formula to determine the amortization of an item is as follows:
A = interest X principal X (1 + interest)number of periods
(1 + interest)number of periods - 1
If the schedule is using monthly payments, the interest rate used is the annual interest rate divided by 12. The value for the number of periods is the number of periods times 12. Amortization schedules are used with long-term debts, such as mortgages, car loans and personal loans.
The purpose of an amortization schedule is to account for compounding interest over time. The amount of interest paid is recalculated after each payment, as the amount of principal will have been reduced by a portion of the payment. This method results in less interest being paid out over the length of the contract, as the principal decreases each period.
An amortization schedule has five columns: time period — either months or years — outstanding balance, payment, interest, and principal paid. The outstanding balance is the full value of the loan, less the amount of payments received.
The payment amount is the full amount paid in each period. The value in the interest column is the portion of the payment that is allocated to interest. The value in the principal column is the portion of the payment allocated to paying down the loan.
The purpose of an amortization schedule is to provide a clear accounting of how much of each payment is going toward the principal and the total amount owed on a loan at any point in time. In every loan, a large portion of the payment is allocated to the interest. Over time, the total amount of interest on the loan is paid down and the amount paid on the principal increases.
There are several different types of amortization that use an amortization schedule. Some examples are straight line, declining balance, annuity or negative amortization. Amortization is very similar to depreciation, simply the inverse. In an amortization schedule, the first payment is made one period from the date the loan was granted. This may be one year later or one month later. The last payment on a loan is usually less than the other payments.