How to Calculate Amortization

How to Calculate Amortization - Amortization refers to a reduction in current debt by paying the same amount in each period (usually monthly). With amortization, debt payments consist of principal payments and interest payments. The principal is the outstanding loan balance. As more and more principal is paid, interest payments are reduced.

Over time, the portion of interest payments per month will decrease and portion payments will increase. Amortization is usually encountered when making a mortgage or car loan, but, in amortization accounting also refers to the reduction of the value of intangible assets over time periodically.

Calculating Interest and Principal Loans in the First Month 

1. Collect information to calculate the amortization of the loan. You need the principal amount of the loan and the interest rate. To calculate the amortization, you need the terms of the loan and the amount of the payment per period. In this case, you will calculate the monthly amortization.

• The principal amount of the loan is the outstanding balance of the current loan (Rp1,000,000,000).

• Interest rate (6%) on the loan is the annual interest rate. You need to convert it into monthly interest rate.

• Term of the loan is 360 months (30 years). Since the amortization is a monthly calculation, the unit year is changed to month.

• The monthly payment amount is Rp5.999.500. The monthly payment amount remains the same, but the portion of principal and interest payments will change monthly.

2. Prepare a spreadsheet. This calculation will involve some moving parts and should be done on the paperwork as you need to include all relevant info in the title account column, for example: Principal, Interest Payment, Basic Payment, and Final Balance.

•  The total number of lines under titles is 360 to record monthly payments.

•  Working paper will make the calculation can be done quickly because if done correctly, the equation is only entered once (or twice, because you used the calculation of the previous month to complete all the next calculation).

• If properly entered, simply pull the equation down and fill in the remaining cells to calculate the amortization throughout the loan term.

• It might be better if you set aside a separate set of columns and include key loan variables (eg monthly payments, interest rates) because you will be able to see the impact of changes on all variables throughout the loan term.

3. Calculate the interest portion of the monthly payment in the first month. This calculation involves several steps. You will need to change your annual or quarterly annual rate to monthly. Monthly interest rate is used to calculate the interest per month.

• An amortized loan, such as a mortgage or car, has a monthly payment terms. Therefore, you need to calculate the interest and principal portion of each payment each month.

• Look for monthly interest rates. From the previous example, (annual interest rate of 6% divided by 12 = monthly interest rate of 0.005).

•  Multiply principal with monthly interest rate: (Rp1,000,000,000 principal multiplied 0.005 = first month interest Rp5,000,000).

4. Calculate the portion of the principal payment in the first month. Subtract with the monthly payment amount with the corresponding month interest to calculate the portion of the principal payment.

• Subtract the related monthly interest payments from monthly payments to receive principal payments: (payment Rp5.995.500 - interest Rp5,000,000 = principal payment of Rp995,500).

• Since some principal has been paid, the interest on the principal will be reduced. Each month, the portion of the principal payments from monthly payments will increase.

5. Use the new principal at the end of the first month to calculate the amortization in the second month. Each time you calculate an amortization, you subtract the principal amount paid in the previous month.

• Calculate the principal amount in the second month: (Principal Rp1,000,000,000 - principal payment of Rp995,500 = Rp99,904,500).

• Calculate interest on the second month: (Principal Rp99.904.500 x 0.005 = Rp4.995.000).

6. Determine the basic payment in the second month. As calculated in the first month, interest in the related month is deducted from the total monthly payments. The remaining amount is the principal payment for the related month.

• Calculate the basic payment in the second month: (Rp5.995.500.55 - Rp4.995.000 = Rp1.000.500).

• The payment of principal in the second month (Rp1.000500) is larger than the first month (Rp995.500). Because the total principal balance is reduced monthly, the interest paid every month is also reduced so that the portion of interest payments on monthly payments is also reduced. In the first month the interest paid is $ 500. In the second month, the interest paid is only Rp4.995.000.

• As the required interest payments are reduced, the portion of monthly payments increases.