A Research on Amortization

Submitted to: Dr. Elvira Aniciete

Submitted by: Abero, Ian Floro Y. Magnayon, Maria Erika Paulyn R. Molinyawe, Angelou H. Sulit, Julius Benedict I. Villar, Kristine B.

Amortization
Long-term debts are normally in the form of long-term notes or bonds with a maturity date that is more than one year. Long-term debts usually involve large sums of money. A borrower may promise to discharge the debt by making periodic partial payments under the amortization method. The amortization method broadly refers to the discharging of a debt by means of a set of regular or irregular and equal or unequal payments. In this research, only a debt discharged by a sequence of equal payments at equal intervals of time is considered. In order to discharge a debt, each payment must be greater than the periodic interest, so that a part of the payment applies to the interest and the remainder applies to the principal until the principal becomes zero.

Amortization Payment Using the Table With amortization, the original amount of the loan or obligation is known (present value). The present value of an annuity table or Table 4 is used to compute the amount of the payment. Amortization payment is found by dividing the present value of the obligation by the presnt value table factor, or Amortization payment = Original amount of Obligation Present Value table factor Example 1: Calvin purchased P1,200,000 worth of gym exercisers and made a P200,000 down payment. He agreed to pay the balance by making equal payments at the end of each month for 15 years. If the interest charged is 12% compounded monthly, what is the size of the monthly payment? Here, PV= P1,000,000 (1,200,000 200,000); i = 1% (12%/12); n = 180 (15 x 12). From Table 4, the table factor is 83.321664. Amortization payment = Amortization payment = Amortization payment = Original amount of Obligation Present Value table factor 1,000,000_ 83.321664 P12,001.68

Amortization Payment Using the Formula Amortization payments may be computed by using the formula Amortization payment = PV x ____i____ 1 (1+i)-n Where: PV i n = amount of the loan or obligation = interest rate per period (nominal rate/periods per year) = number of periods (years x periods per year)

Which can therefore be written as: Amortization payment = PV x ____j/m____ 1 (1+j/m)-n Example 2: What amortization payment if required each month, at 18% interest, to pay off P50,000 in 3 years? Here, 1.5% (18%/12) interest rate per period and 36 periods (3 years x 12 periods per year) are used. Amortization payment = PV x ____i____ 1 (1+i)-n Amortization payment = 50,000 x ____.015____ 1 (1+.015)-36 Amortization payment = 50,000 x ____.015____ .4149103 Amortization payment = 50,000 x.0361524 Amortization payment = P1,807.62 Outstanding Principal Oftentimes both the creditor and the borrower must know the amount of the outstanding principal or the unpaid balance on a certain date. The information may be needed for various reasons: it may be necessary for accounting purposes; the creditor may want to sell the unpaid balance; the borrower may wish to know his or her equity from an investment (such as house

purchase price minus unpaid balance); or the creditor and the borrower may agree to settle the balance on an earlier date. The outstanding principal may be determined under two types of arrangements: (a) all periodic payments are equal, or (b) all periodic payments, except final payment, are equal. All periodic payments are equal When necessary for all the periodic payments to be the same, the method given in Example 1 (under amortization payment by table) should be used to find the size of payments. The outstanding principal on a certain date is the present value of an annuity formed by the remaining unpaid payments, as shown below. Example: Refer to Example 1. Find the outstanding principal after Calvin made the monthly payments for 10 years. Here Pmt = P12,001.68; i = 1% (12%/12); n = 60 (180 - 120). From Table 4, the table factor is 44.955038. Outstanding principal = 12,001.68 x 44.955038 Outstanding principal = P539,535.98 Instead of using the table as presented in the previous examples, the outstanding principal on a certain date may be obtained by constructing an amortization schedule such as that shown in the next example. Outstanding Principal using an Amortization Schedule Example 4: A debt of P40,000 is to be amortized by equal payments at the end of every quarter for 1 years. If the interest charged is 12% compounded quarterly, find the outstanding principal after each payment is made. The outstanding principal is computed by first finding the size of the periodic payment and then constructing an amortization schedule. Here, PV = P40,000; i = 3% (12%/4); n = 6 (1 x 12). From Table 4, the table factor is 5.417191. Amortization payment = Amortization payment = Amortization payment = Original amount of Obligation Present Value table factor __40,000__ 5.417191 P7,383.90

The amortization schedule if shown below:

*Corrected for P0.01 discrepancy ** Of the previous period. For Example P33,816.10 = 40,000 6,183.90.

Observe the amortization schedule of the Example 4. Column (2) shows the outstanding principal after each payment is made. For Example, the Outstanding principal after the fourth payment is P14,128.87. The fourth payment is made at the end of the fourth period. Thus, P14,128.87 is also the principal at the beginning of the fifth period. The discharged portion of the original principal after the fourth period is P25,871.13 [40,000 -14,128.87, or 6,183.90 + 6,369.42 + 6560.50 + 6,757.31; see column (5) of the schedule]. Each outstanding principal shown in Column (2) may be checked. For example, the outstanding principal after the fourth payment is made is the present value of an annuity formed by the two remaining unpaid payments. Here Pmt = 7,383.90; i = 3% (12%/4); n = 2 (remaining quarterly payments). From the table 4, the present value of an annuity table factor is 1.913470. Outstanding principal = 7,383.90 x 1.913470 Outstanding principal = P14,128.87 The last figures in Columns (2) and (5) should be the same. The total for Column (5) should be equal to the original principal, P40,000. Theoretically, all the payments should be equal. However the schedule shows that the sixth payment if P7,383.91. The discrepancy of one centavo results from rounding all computations to the nearest centavos. For example, interest due at the end of the sixth period is computed as follows: Interest = 7,168.84 x 3% = P215.0652 or P215.07

The size of the sixth payment, therefore, is 7,168.84 + 215.07 = P7,383.91. The final payment covers the outstanding principal at the beginning of the last payment interval and the interest due thereon. Here, the interest for each period is computed by the simple interest method. It should be observed that when a debtor makes each of the simple interest payments on the interest date, the simple interest method is actually a compound interest method. Also, note that as the principal gradually reduced, the periodic interest becomes smaller after each payment is made. Thus, a greater portion of each equal payment is used in reducing the principal. All periodic Payments Except the Final Payment are Equal Sometimes the size of each payment is not obtained by the method explained in the previous section. Instead, it is specified by the agreement between creditor and the debtor, and a more convenient or rounded figures, such as P500 or P1,000, is decided upon as the size of each payment. The exact size of the final payment is not known. It may or may not equal the size of the other payments, The exact size of the final payment may be known by constructing an amortization schedule. Example 5: A debt of P60,000 is to be discharged by payments of P10,000 at the end of every month. Interest charged is 12% compounded monthly. Find (a) the number of payments, (b) the outstanding principal after each payment is made, (c) the interest included in each payment, (d) the principal included in each payment, and (e) the size of the final payment and the total of the payments.

Example from ABN AMRO Bank:

Given: Amortization Schedule: R m t i n : 160.36 : 12 : 12 months / 1 year : 1.1% : 12

Find Ao Ao= R[1-(1+i)-n] i Ao= 160.36[1-(1+.011)-12] .011 Ao= 1793.51