A loan is a contract by which one of the parties (which we call a lender) gives money to another (called the borrower). For its part, the borrower agrees to return to the lender all the money loaned plus interest, setting specific conditions and time limits for this.
The repayment of a loan is precisely the process that the borrower follows to return the initial money, plus interest, to the lender.
How do I calculate the amortization of a loan?
Depending on the type of amortization, it will be carried out in one way or another. The simplest case is that of repayment with a single repayment, in which, at the end of the loan term, we will pay in one go both the money loaned initially and the interest. Let’s see an example:
In this case, $ 15,000 has been loaned, with interest at 6% per year and a term of 5 years to repay the loan. Thus, we can calculate that, in order to amortize this loan, we will have to repay a total of $ 20,073.38 over the five years ($ 15,000 of the money they lent us at the beginning plus $ 5,073.38 in interest).
However, the usual process of amortization of a loan and its calculation is more complex, and it is necessary to know all the elements that comprise it in order to be able to return it, that is, amortize it. Go for it! These are the components of a loan:
- Nominal of the loan or principal: Amount of money that they give us when they grant us the loan and that must be returned together with the interest.
- Amortizing term of the period or installment to pay: Amount of money that must be paid from time to time (as agreed) to gradually return the loan. A part of this amount will serve to pay the interests and another to pay the principal of the loan. Depending on the amortization system that we apply, we will dedicate more or less money for each thing.
- Living capital of the period: As we pay the loan installments, the debt we have will decrease. The living capital of the period is the amount that we still owe to the lender. In other words, it is not all the debt (nominal + interest) but only the part of the nominal that we still have to pay back.
- Amortized capital up to a certain period: It is an identical concept to that of living capital but seen from another point of view. If the living capital is the part of the nominal that we have left to pay, the amortized capital is precisely the part of the nominal that we have already paid.
- Period interest installment: It is the part of the installment of a loan that we must pay periodically and that is destined to amortize only the interests, not the principal of the loan.
- Period amortization fee: It is the part of the loan installment that we must pay periodically and that is destined only to pay the principal or nominal amount of the loan, not the interest. In the case of loans that respond to this scheme, the total amount to be amortized will be the sum of all the amortization terms or the installments of the loan.
Loan amortization tables
All the aforementioned concepts are usually represented within a table called the amortization table of a loan. Although it does not have a fixed structure, and not all of these components are always covered, the typical form of a depreciation schedule usually looks like this:
There is no single amortization system, but there are several options, each with its advantages and disadvantages. In general, the French amortization system is the most frequent in practice and is the one that any financial institution usually applies by default (unless another amortization method is specified). But what does the French amortization system consist of?
French amortization system
The French amortization system is characterized by having constant quotas. This implies that at the beginning of the amortization we will have to pay more interest and less at the end.
The amortization term, that is, the total amount to be paid in each period, is the same throughout the loan and, therefore, almost everyone chooses to request a loan under this system, since it allows us to more easily manage our finance.
Advantage? That, in advance, you know how much you have to pay in each period of time (as long as the interest rate does not vary, of course).
And, how disadvantageous? That the principal of the loan does not begin to be amortized, in its majority, until the last payments of the loan. Let’s see how this method works with an example:
In this example, we see that the borrower has to pay the lender a total of 14,215.73 euros as an annual fee for the duration of the loan.
A part of that amount will go to pay the interest generated and the other will serve to return part of the nominal or principal of the loan. Thus, in the first installment to be paid, of the established 14,215.73 euros, 6,500 (50,000 x 13% interest) will be paid as interest, while the remaining $ 7,715.73 will be used to amortize the principal of the loan, with what is subtracted from the initial $ 50,000, leaving $ 42,284.27 payable.
In the next installment (always $ 14,215.73), the amount that must be dedicated to paying as interest decreases, since this time it will be $ 5,496.95 ($ 42,284.27 x 13% interest rate), leaving $ 8,718.78 discounted from the nominal. Thus, after the second installment, there will be a nominal amount of $ 33,565.49.
This process continues for subsequent installments to be paid, as reflected in the table. As we said, in the French system, the installment to pay is always the same, but, as time passes, in each of them the amount to pay interest will decrease and the amount dedicated to amortizing capital will increase. At the end of the loan, the lender will have paid the borrower a total of $ 71,078.65 for having received $ 50,000 five years ago.
What is loan amortization insurance?
The amortization insurance of a loan is an insurance that covers the holder in the event of death or great disability on all or part of the capital owed (depending on the percentage that you have insured). With this insurance, in the event of death or inability to pay the loan, the relatives are free to have to continue with the payment, since the insurance entity will do so.
Is it compulsory to take out amortization insurance?
No, it is not compulsory insurance, although it is recommended if we want to be more relaxed when applying for a loan or a line of credit.
For example, at Good Credit, we have launched Calma insurance for our credit lines of up to $ 3,000. In the event of death or permanent disability, Calma will cover up to $ 2,600, while, if the disability is temporary, it will cover up to $ 1,300, the same amount as in the event of hospitalization or unemployment.
In any case, it is you who must evaluate whether or not you are interested in contracting this type of insurance, analyzing the installments of your loan and its viability.