Definition
An amortization schedule is a chart that shows how installment payments are used to pay interest and reduce principal over the life of the loan.
Analysis
The purpose of an amortization schedule is to allow borrows to understand the way in which interest is charged on an installment loan. They can see how initial payments are mostly allocated toward interest, while final payments are almost all principal payments.
Borrowers are able to see the total cost of the loan as well as the total interest payments. As a result, borrowers can gain a better understanding of what the cost of the loan is by viewing an amorization schedule.
Mortgage lenders are required to provide a sample amortization schedule to homebuyers so that the borrower can understand that principal payments are very small in the first few years of a mortgage loan. This sample must be representative of rates that some homebuyers have been charged, but it does not necessarily match the interest rate that the borrower might receive.
In other words, actual costs could be much higher or lower than what is expressed by a sample amortization schedule. Nonetheless, those actual costs are included within the loan disclosures.
Other lenders are not required to provide an example of an amortization schedule. Similarly though, the actual costs of the loan are disclosed to the borrower at the time of the sale.
Here is an example of an amortization schedule on a $100,000 mortgage loan. The principal and interest payments are amortized over a 30 year term, with 12 equal payments due each year.
The total cost of the loan is $221,658.19, of which $121,658.19 is paid in interest and $100,000 is the principal amount that is repaid. The first payment of $615.72 consists of $94.88 to be paid toward principal and $520.83 in interest costs. The last payment is the remaining $612.53, of which $609.34 is principal, and $3.19 is payable to interest.
An amortization schedule allows you to see how the interest costs are calculated and how the installment payments are applied to interest and principal. It also shows you how the total loan costs are calculated. This example may seem like a high price to pay for a mortgage loan, but it actually is a relatively low rate of interest. Higher interest rate loans can have substantially higher borrowing costs!
