AMORTIZATION

Amortization
Amortization Schedule
Outstanding Balance

Amortization
Amortization method: repay a loan by means of
installment payments at periodic intervals
This is an example of annuity
We already know how to calculate the amount of
each payment
Our goal: find the outstanding principal (balance)
Two methods to compute it:
prospective
retrospective

Two Methods
Prospective method:
outstanding principal at any point in time is equal
to the present value at that date of all remaining
payments
Retrospective method:
outstanding principal is equal to the original
principal accumulated to that point in time minus
the accumulated value of all payments previously
made
Note: of course, this two methods are equivalent.
However, sometimes one is more convenient than
the other

Examples
(prospective) A loan is being paid off with
payments of 500 at the end of each year for the
next 10 years. If i = .14, find the outstanding
principal, P, immediately after the payment at the
end of year 6.
(retrospective) A 7000 loan is being paid off with
payments of 1000 at the end of each year for as
long as necessary, plus a smaller payment one
year after the last regular payment. If i = 0.11 and
the first payment is due one year after the loan is
taken out, find the outstanding principal, P,
immediately after the 9th payment.

Amortization Schedule

Goal: divide each payment (of annuity) into two parts interest and
principal
Amortization schedule table, containing the following columns:
payments
interest part of a payment
principal part of a payment
outstanding principal

Amortization schedule:

Example:
5000
at 12 % per year
repaid by 5 annual
payments

Duration
(Period)

Periodic
Payment

Interest
Paid

Principal
Repaid

Outstanding
Principal
5000.00

1387.05

600.00

787.05

4212.95

1387.05

505.55

881.50

3331.45

1387.05

399.77

987.28

2344.17

1387.05

281.30

1105.75

1238.42

1387.05

148.61

1238.44

Outstanding
principal
P
Payment
X
t-1

Interest earned during

interval (t-1,t) is iP
Therefore interest portion
of payment X is iP
and principal portion is
X - iP

Recall: in practical problems, the outstanding principal P

can be found by prospective or retrospective methods

Example
A 1000 loan is repaid by annual payments of 150, plus a
smaller final payment. If i = .11, and the first payment is
made one year after the time of the loan, find the amount
of principal and interest contained in the third payment

Example 1
A loan of 5000 at 12% per year is to be repaid by
5 annual payments, the first due one year hence.
Construct an amortization schedule.
Given: A 5000

t5
n5

r 0.12
i 0.12

m 1

Required: R and Amortization schedule

Formula:

A i

1 1 i

5000 0.12
R
5
1 1 0.12
R 1387.05

General rules to obtain an amortization schedule

Duration

Payment

Interest

Principal
Repaid

I.

Outstanding
Principal

i = 12 %

5000.00

1387.05

1387.05

1387.05

1387.05

1387.05

600
787.05
505.55 881.50
399.77 987.28
281.30 1105.75
148.61 1238.44

4212.95
3331.45
2344.17
1238.42
0

Take the entry from Outs. Principal of the previous row, multiply it by
i, and enter the result in Interest
II. Payment Interest = Principal Repaid
III. Outs. Principal of prev. row - Principal Repaid = Outs. Principal
IV. Continue

Example 2

A 1000 loan is repaid by annual payments of 150, plus a smaller

final payment. The first payment is made one year after the time
of the loan and i = .11. Construct an amortization schedule

Given: A 1000

R 150

i 0.11

Required: n , amortization schedule , concluding payment

A i
log 1
R

n
log 1 i

Formula:

1000 0.11
log 1

150

log 1 0.11

n 12.66

Example 3
A P20,000 loan at 18% compounded quarterly is to be
amortized every 3 months for two years. Find the
quarterly payment and construct an amortization
schedule.

Given: A 20000

t2
n8

r 0.18
i 0.045

m4

Required: R and Amortization schedule

Formula:

A i

1 1 i

20 , 000 0.045
R
8
1 1 0.045
R 3 , 032.19

Example 4
A debt of P30,000 with interest at 23% compounded
quarterly will be discharged; interest included, by
payments of P5,000 at the end of each three months for
as long as it is necessary.

Given: A 30000 R 5000 r 0.23

m4

i 0.0575

Required: n, Amortization schedule , concluding

payment

30 , 000 0.0575
A i

Formula:
log 1
log 1

n
log 1 i

n 7.57

5 , 000

log 1 0.0575

Two Methods
Prospective method:

Outstanding Balance (Remaining Liabilities)

after the kth payment
OB R

1 1 i n k

Interest paid after the kth payment

I n k R 1 1 i

n k 1

Principal repaid after the kth payment

PR R I n k

Example 3
A P20,000 loan at 18% compounded quarterly is to
be amortized every 3 months for two years. Find
the following:
a)The remaining liabilities just after the 2 nd payment
b)The outstanding balance after one year.
Solution:

1 1 i n k

OB R

1 1 0.045 6

a) OB 3 , 032.19

0.045

15 , 639.65

1 1 0.045 4

b) OB 3 , 032.19

0.045

10 , 878.06

Example 3
A P20,000 loan at 18% compounded quarterly is to
be amortized every 3 months for two years. How
much of the 6th payment goes to interest and how
much goes to the principal?
1 1 i
I

R

Solution: n k

n k 1

3
I n k 3 , 032.19 1 1 0.045

375.09

PR R I n k 3 , 032.19 375.09 2657.10

Two Methods
Retrospective method:

Outstanding Balance (Remaining Liabilities)

after the kth payment
OB A 1 i

1 i k 1

Example 4
A debt of P30,000 with interest at 23%
compounded quarterly will be discharged; interest
included, by payments of P5,000 at the end of
each three months for as long as it is necessary.
Find the following:
a)Outstanding principal at the end of 1.5 years
k 4 1.5 6

OB A 1 i

1 i k 1

1 0.0575 6 1
6

30 , 000 1 0.0575 5 , 000

0.0575

41, 956.91 34 , 657.71 7 , 299.20

Example 4
A debt of P30,000 with interest at 23%
compounded quarterly will be discharged; interest
included, by payments of P5,000 at the end of
each three months for as long as it is necessary.
Find the following:
b) Outstanding balance just after the 5 th payment
k5

OB A 1 i

1 i k 1

1 0.0575 5 1
5

30 , 000 1 0.0575 5 , 000

0.0575

39 , 675.57 28 , 045.12 11 , 630.45

Example 4
A debt of P30,000 with interest at 23%
compounded quarterly will be discharged; interest
included, by payments of P5,000 at the end of
each three months for as long as it is necessary.
Find the following:
c) Concluding payment
k7

1 0.0575 7 1
7

OB 30 , 000 1 0.0575 5 , 000

0.0575

44 , 369.43 41 , 650.53 2 , 718.90

SINKING FUNDS
This is an annuity that is invested
for a specific purpose and is
continued for a predefined period.
Examples:
Childs college fund
To buy a new computer in 3 years time.

SINKING FUNDS
In creating a fund it is important to know the
periodic deposit and the amount to be put up.
1 i k 1

AF R

S i
R
n
1 i 1
IF R 1 i

k 1

k 1

I R 1 i
1

amount in the fund after

the kth deposit
periodic deposit
increase in fund on the
kth deposit
interest earned in fund
on the kth deposit

Example 1
A man needs P30,000 at the end of 3 years. He decides
to put his savings every six months that earns 10%
converted semiannually. Construct the sinking fund
schedule.

Given: S 30 , 000

t3
n6

r 0.10
i 0.05

m2

Required: R and Sinking Fund schedule

Formula:

S i

1 i

30 , 000 0.05
R
6
1 0.05 1
R 4 , 410.52

General rules to obtain a sinking fund schedule

I.

Duration

Periodic
Deposit

Interest in
Fund

Increase
in Fund

Amount in
Fund

4,410.52

4,410.52

4,410.52

4,410.52

4,410.52

4,410.52

0.00
220.53
452.08
695.21
950.50
1, 218.55

4 , 410.52
4 , 631.05
4 , 862.60
5 ,105.73
5 , 361.02
5 , 629.07

4 , 410.52
9 , 041.57
13 , 904.17
19 , 009.90
24 , 370.92
29 , 999.99

i = 0.05

Take the entry from Amount in Fund of the previous row, multiply it by i,
and enter the result in Interest in Fund
II. Deposit + Interest = Increase in Fund
III. Amount in Fund of prev. row + Increase in Fund = Amount in Fund
IV. Continue

Example 1... continuation

Given: S 30 , 000

R 4 , 410.52

t3
n6

r 0.10
i 0.05

m2

a. Find the amount in fund after the 4 th deposit

1 i k 1
1 0.05 4 1
4 , 410.52

AF R

i
0.05

19 , 009.90

b. Find the interest earned in the 6 th deposit

k 1

I R 1 i
1 4 , 410.52 1 0.05 5 1

1 , 218.55

c. Find the increase in fund in the 5th deposit

IF R 1 i

k 1

4
4 , 410.52 1 0.05

5 , 361.01

Sinking Funds
Alternative way to repay a loan sinking
fund method:
Pay interest as it comes due keeping
the amount of the loan (i.e.
outstanding principal) constant
Repay the principal by a single
lump-sum payment at some point in
the future

lump-sum payment L
interest

iL
0

iL
2

iL

..
n

Loan L

Lump-sum payment L is accumulated by periodic

deposits into a separate fund, called the sinking fund
Sinking fund has rate of interest j usually different from
(and usually smaller than) i
If (and only if) j is greater than i then sinking fund method
is better (for borrower) than amortization method

Examples
John borrows 15,000 at 17% effective annually. He agrees to
pay the interest annually, and to build up a sinking fund which
will repay the loan at the end of 15 years. If the sinking fund
accumulates at 12% annually, find
the annual interest payment
the annual sinking fund payment
his total annual outlay
the annual amortization payment which would pay off this
loan in 15 years
Helen wishes to borrow 7000. One lender offers a loan in
which the principal is to be repaid at the end of 5 years. In the
mean-time, interest at 11% effective is to be paid on the loan,
and the borrower is to accumulate her principal by means of
annual payments into a sinking fund earning 8% effective.
Another lender offers a loan for 5 years in which the
amortization method will be used to repay the loan, with the
first of the annual payments due in one year. Find the rate of
interest, i, that this second lender can charge in order that
Helen finds the two offers equally attractive.