# How Loan Amortization Works

### Determine how much finance you can afford by reverse engineering a loan payment. Determine your yearly interest payments for tax purposes

Loan Amortization Methods:

Using an online loan calculator or a template spreadsheet like those offered by Microsoft Excel is the simplest way to amortize a loan. However, you can use the equation below if you’d rather amortize a debt by hand. You will require the total loan amount, the loan amortization period (the time frame for loan repayment), the frequency of payments (for example, monthly or quarterly), and the interest rate.

Use this equation to get an amortized loan’s monthly payment:

a / {[(1 + r)n]-1} / [r (1+r)n] = p, where

A represents the total loan amount, and R represents the monthly interest rate (annual rate / annual payments).

The overall number of payments is n. (number of payment per year x length of loan in years)

Consider a two-year amortization on a \$15,000 auto loan with a 6% interest rate. The calculation might look like this:

The monthly amount is \$15,000 / [(1+0.005)24]-1 / [0.005(1+0.005)24] = \$664.81.

Then, multiply the total loan amount by the interest rate to see how much of each payment will go toward interest. If you plan to make monthly payments, divide the answer by 12 to get how much interest you’ll pay each month.

By deducting the interest payment from your total monthly payment, you may calculate how much of each payment will go toward the principal.

Subtract the amount of principal paid during that time from the outstanding debt from the previous month to determine the outstanding balance each month. Use the identical calculations for consecutive months, but instead of starting with the initial loan amount; use the outstanding principal balance from the prior month.

To determine how long it will take to pay off the loan in the example above, first determine how much interest you’ll pay each month by multiplying \$15,000 by 6%—in this case, \$900—and then dividing by 12 installments. The borrower will be required to pay \$75 in interest during the first month in this scenario [\$15,000 x 0.06 / 12 = \$75].

Conclusion

Therefore, using this amortization plan for a loan, borrowers may see the main and interest components of each monthly payment as well as the balance still owing after each payment. 