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What is Amortization?

Amortization is the gradual repayment of a debt over time.

There are many different ways you can repay a loan and many different amortization methods.  There three (3) most common amortization methods involve fixed-rate, variable-rate and interest-only loans. In an effort to keep things simple, we only discuss here the above common amortization methods.

Fixed-rate

A fixed-rate loan is when the borrower repays the loan in installments at the same interest rate for each repayment period.

Let's say the borrower has a $1,000 loan that will be repaid weekly over the course of a year at 6.50% nominal rate. The first few payments would look like the following:

Number Date Days Payment Interest Principal Balance of Principal
0 01/01         1,000
1 01/08 7 20.25 1.25 19.00 981.00
2 01/15 7 20.25 1.22 19.03 961.97
3 01/22 7 20.25 1.20 19.05 942.92
4 01/29 7 20.25 1.18 19.07 923.85
...            

Fixed-rate loans are common and easy to calculate. However, when I personally shopped for a loan to purchase my first home, not one lender would consider a fixed-rate loan.  Interest rates were raising and the bankers knew they going up. Every lender tried to persuade me to sign up for a variable-rate loan.

Variable-rate

A variable-rate loan is when the borrower repays the loan in installments at an interest-rate that changes at least once during the repayment of the loan. Generally the loans starts out a low, very enticing interest rate and then after 1, 3, or 5 years (the adjustment period), the rate changes to the prevailing interest rate.

When I shopped for a loan to purchase my first home, lender after lender proposed 3-year variable rate loans to my wife and I. The initial rate was lower than what I would have attained from a fixed-rate loan!!!! However, after the adjustment period of three years, the rate would then adjust to the prevailing market rate, which I knew was going to be much higher.

Interest Only

A mortgage is “interest only” if the monthly payment does not include any repayment of principal for some period.  The payment consists of interest only.  At the end of the term, the initial loan balance is paid off in one-lump sum. Examples of how to calculate interest-only loans by hand are discussed here.

Banks want to make money via interest and fees; they also want to get the loan signed.  I have seen some exotic loans in my day that are combinations of the above methods. Study the terms and conditions carefully and shop around.  Its free to shop!

Please call (608) 444-6575 or e-mail (info@powerofinterest.com) if you have any problem downloading or installing software.

 
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