To illustrate, let's assume a lender proposes to amortize a $60,000 loan at 4% annual interest over a 3-year period. This will require 36 monthly payments of $1,771.44 each. The first payment will consist of an interest payment of $200.00 ($60,000 X 4% X 1/12) plus a principal payment of $1,571.44 ($1,771.44 - $200.00). After the first payment is made, the principal balance will be $58,428.56 ($60,000.00 - $1,571.44). The second monthly payment of $1,771.44 will consist of interest of $194.76 ($58,428.56 X 4% X 1/12) plus a principal payment of $1,576.68 ($1,771.44 - $194.76). After the second payment is made, the remaining (or unpaid) principal balance will be $56,851.88.
The 36th and final monthly payment of $1,771.44 will consist of interest of $5.89 (the principal balance after the 35th payment, which will be $1,765.55, times 4% X 1/12) plus a principal payment of $1,765.55. After the 36th payment the loan balance will be zero. In other words, the loan will have been amortized over its 3-year term.
A listing of each month's interest and principal payments (and the remaining, unpaid principal balance after each payment) is referred to as an amortization schedule.
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