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MATH 109 Amortization

One of the most useful arithmetic formulas in mathematics is the monthly payment for
an amortized loan. Here are some standard questions that apply whenever you borrow
money to buy a car or a house:

1. If you borrow \$ P (principal) at a fixed interest rate r to be paid back in n monthly

payments, then what is the monthly payment M ?

2. After m monthly payments of \$ M , what is your balance due? Of what you have
€ paid in interest?
paid, how much of the loan have you paid off and how much have you

3. How do you create an amortization chart that shows how much goes to interest, how

much goes to principal, and the remaining balance after each payment.

4. If an additional fixed amount A is paid each month to help reduce the principal, then
what will be you balance after m monthly payments?

The Monthly Payment

For a principal balance of P with fixed interest rate r (in decimal), the amount due each
month to pay off the loan in n monthly payments is given by

€ P × ( r12 )
M = −n .
1 − (1 + r12 )

The balance due after k payments is

r  12M   r 
k k
€ 
Bk = P1+  + 1− 1+  
 12  r   12  

Let B0 be the initial balance and let Bi the balance after the i th payment.

The interest on i th payment is given by Ii = Bi −1 × r / 12 .

The principal on the i th payment is given by Pi = M – Ii .

The balance after the i th payment is Bi = Bi−1 – Pi .

Finally, the umber of months required to pay off balance B with monthly checks of C is
€  B r€
−log1− 
 12C 
m=
log(1+ r /12)

Example 1. Suppose you are buying a house. After your downpayment, closing costs,
etc., you are to finance \$125,000 at 5.25% to be paid back over 30 years.

(a) Find the monthly payment.

(b) How much will you pay over the course of 30 years? How much goes to interest?

(c) On the first few payments, show how much of your payment goes to interest, how
much goes to principle, and the balance due.

(d) After just 10 years of payments:

(i) How much have you paid in? (ii) What is the balance due?
(iii) How much of the loan have you paid off?
(iv) How much of your payments have gone to interest?

(v) You decide to try to pay off the balance 12 more years of payments. Compute the
monthly payment that would be required to pay off the balance B from (d) in 12 years at
5.25% interest.

(vi) On second thought, you decide to start paying \$1500 a month after the initial 10
years of payments. How many more payments will be required? Also express the
result as xx years, yy months (e.g. finish in 9 yrs, 3 months of payments).

Solution. (a) For 30 years, there are 360 payments. The monthly payment is

125000 × ( .052512 ) 546.875

M = −360 = = \$690.25.
1 − (1 + .052512 ) 1 − (1.004375 )−360

(b) After 30 years, or 360 payments, you will pay \$690.25 × 360 = \$248,490. The amount
paid to interest is \$248,490 – \$125,000 = \$123,490.

(c) The interest on the first payment is I1 = B0 × r / 12 = 125,000 × 0.0525/12 = \$546.88.

So the amount to principal is \$690.25 – \$546.88 = \$143.37, which gives a balance of
\$124,856.63.
Payment To Interest To Principal Balance
– – – \$125,000

2. \$690.25 \$546.25 \$144.00 \$124,712.63

3. \$690.25

4. \$690.25
Notes: (a) If your downpayment is at least 20%, or when your balance drops below
80% the value of the house, then you no longer have to escrow your property taxes and
insurance. If you do escrow, then your monthly payment is actually higher than M , but
this additional amount is only for insurance and taxes and does not affect the loan.

(b) Due to the rounding of M to the nearest cent, the last payment may not actually be
\$690.25. If you make a complete amortization chart of the process, then the last
payment actually will be \$694.02, which makes the total payment \$248,493.77.

(d) (i) After 10 years, or 120 payments, you have paid in \$690.25 × 120 = \$82,830.

(ii) But the balance due is still

 .0525  120 12 × 690. 25
B120 = 125, 000 ×  1 + + × (1 − (1+.0525 / 12 )120 )
 12  . 0525
12 × 690.25
= 125, 000 × 1.004375120 + × 1 − 1.004375120
( )
.0525
= \$102, 436. 08 .

(iv) Thus, the amount paid to interest is \$82,830 – \$22,563.92 = \$60,266.08.

(v) For 12 years, there are 144 payments. The monthly payment for a balance of
\$102,436.08 is now

(
102436.08 × .052512 ) 448.15785
M = −144 = 1− 1.004375 −144 = \$960.32.
(
1− 1+ .052512 ) ( )

(vi) If you start paying \$1500 a month after the initial 10 years of payments, then the
number of remaining payments is €

 Br   102436.08 ×.0525 
−log1−  −log1− 
 12C   12 ×1500  −log(1− .2987719)
m= = = = 81.3
log(1+ r /12) log(1+ .0525 /12) log(1.004375)

Thus, it takes 82 months, which is 6 years and 10 months of payments.

Exercises

1. You are buying a car and you must finance \$22,000 at 4.8% over a five-year period.

(a) What is the monthly payment?

(b) How much will you pay over the course of 5 years? How much goes to interest?

(c) For the first two payments, show how much of your payment goes to interest, how
much goes to principle, and the balance due.

(d) After just 2 years of payments:

(i) How much have you paid in? (ii) What is the balance due?
(iii) How much of the loan have you paid off?
(iv) How much of your payments have gone to interest?

(e) If you pay an extra \$150 per month from the start, then what is your balance due
after two years of payments?

2. You are buying a house and you must finance \$150,000 at 5.4% over a 30-year period.

(a) What is the monthly payment?

(b) How much will you pay over the course of 30 years? How much goes to interest?

(c) For the first two payments, show how much of your payment goes to interest, how
much goes to principle, and the balance due.

(d) After 10 years of payments:

(i) How much have you paid in? (ii) What is the balance due?
(iii) How much of the loan have you paid off?
(iv) How much of your payments have gone to interest?

(v) You decide to try to pay off the balance 8 more years of payments. Compute the
monthly payment that would be required to pay off the balance B from (d) in 8 years at
5.4% interest.

(vi) On second thought, you decide to start paying \$1300 a month after the initial 10
years of payments. How many more payments will be required? Also express the
result as xx years, yy months (e.g. finish in 9 yrs, 3 months of payments).
Solutions

1. (a) There are 60 monthly payments over 5 years. The payment is

22000 × 0. 048 / 12 88
−60 = −60 = \$413.15;
 . 048  1 − 1.004
1 − 1 + 
 12 

(c) Payment 1 – To interest: 22000 × 0. 048 / 12 = \$88; To principle: 413.15 – 88 = \$325.15.

New Balance after 1st payment = 22,000 – 325.15 = \$21,674.85.

Payment 2 – To interest: 21, 674. 85 × 0.048 / 12 = \$86.70; To principle: 413.15 – 86.70 =

\$326.45. Balance after 2nd payment = 21,674.85 – 326.45 = \$21,348.40.

(d) (i) After 24 payments, you have paid in 24 × 413.15 = \$9915.60.

(ii) The balance due is

 .048  24 12 × 413.15
B24 = 22, 000 ×  1 +  +
 × (1 − (1+. 048 / 12)24 )
12 . 048
= 22, 000 × 1.004 24 + 103287.5 × 1 − 1.00424
( )
= \$13 ,826. 68 .

(iv) So 9915.60 – 8173.32 = \$1742.28 has gone to interest after 24 payments.

(e) If you pay \$563.15 per month (an extra \$150), then after 24 payments the balance
due is

 .048  24 12 × 563.15
B24 = 22, 000 ×  1 +  +
 × (1 − (1+. 048 / 12 )24 )
12 . 048
= 22, 000 × 1.004 24 + 140787.5 × 1 − 1.00424
( )
= \$10 ,056.12 .

2. (a) There are 360 monthly payments over 30 years. The payment is

150000 × 0. 054 / 12 675

−360 = = \$842.30.
 . 054  1 − 1. 0045−360
1 − 1 + 
 12 

(c) Payment 1 – To interest: 150000 × 0. 054 / 12 = \$675; To principle: 842.30 – 675 =

\$167.30. New Balance after 1st payment = 150,000 – 167.30 = \$149,832.70.
Payment 2 – To interest: 149, 832. 70 × 0.054 / 12 = \$674.25; To principle: 842.30 – 674.25
= \$168.05. Balance after 2nd payment = 149,832.70 – 168.05 = \$149,664.65.

(d) (i) You have paid in 120 × 842.30 = \$101,076 after 10 years.

 . 054  120 12 × 842.30

B120 = 150,000 ×  1 + 
 + × (1 − (1+ .054 / 12 )120 )
12 .054
= 150,000 × 1. 0045120 + 187177.78 × 1 − 1.0045120
( )
= \$123 , 457. 69 .

(iii) You have paid off 150,000 – 123,457.69 = \$26,542.31.

(iv) So 101,076 – 26,542.31 = \$74,533.69 has gone to interest after 10 years of payments.

(v) For 8 years, there are 96 payments. The monthly payment for a balance of
\$123,457.69 is now

(
123457.69 × .054 12 )
555.559605
M = −96 = −96 = \$1586.58.
1− (1.0045)
(
1− 1+ .054 12 )
(vi) If you start paying \$1300 a month after the initial 10 years of payments, then the
number of remaining payments is €

 Br   123457.69 ×.054 
−log1−  −log1− 
 12C   12 ×1300  −log(1− .4273535423)
m= = = = 124.16448
log(1+ r /12) log(1+ .054 /12) log(1.0045)