Introduction to Amortization

• Definition of Amortization:
  • Process of paying off a debt over time through regular payments.
• Practical examples provided in a loan context.

Loan Application Scenario

• Example loan amount:
  • $30,000
• Application to bank for the aforementioned loan.
• Relevant financial components discussed:
  • Present value of ordinary annuity (PVOA).

Amortization Formula

• Key formula for calculating the present value of an annuity:
  • $PV = CF imes \left(1 - \left(1 + r\right)^{-n}\right)$
  • Where:
  • PV = Present Value
  • CF = Cash Flow (payment per period)
  • r = interest rate (per period)
  • n = total number of periods
• Importance of memorizing this formula for calculations.

Terms and Definitions

• Clarified terms relevant to loans:
  • Cash Flow (CF):
  • Refers to earnings, salary, or assets one has.
  • Principal:
  • The amount borrowed; to be repaid back usually over a set period.
  • Interest Rate:
  • Rate at which interest accumulates on the loan amount.
  • Debt Service Ratio:
  • Bank policy stipulating that total debt payments should not exceed a certain percentage of income; mentioned was 4%.

Calculation of Loan Qualification

• Given criteria:
  • Applicant requires $30,000 but may not be qualified for the entire amount.
  • Requirement to compute the maximum loan amount qualified for is derived from present value calculations.

Interest Rates and Calculations

• Interest rate in scenario:
  • 18% annually.
• Conversion of percentage to decimal for calculations:
  • $r = \frac{18}{100} = 0.18$

Steps for Amortization Calculation

1. Calculate Present Value using cash flow and interest rate methods.
2. Establish amortization table detailing:
   • Beginning Balance
   • Interest
   • Principal Paid
   • Ending Balance
3. Explanation of each line in amortization table:
   • 6006.00 per year determined for a specific duration.
   • Balance brought forward and carry forward established as critical figures.

Intuitive Understanding

• Use relatable analogies and friends' conversations to simplify understanding of how the loan and amortization work, e.g.,
  • Personal anecdotes relating to borrowing and repayment.

Breakdown of Amortization Table

• Layout for amortization detailing:
  • BB (Balance Brought forward)
  • I (Interest)
  • P (Principal)
  • CF (Cash Flow) (Amount paid periodically)
• Instructions on calculating these figures.

Calculating Interest, Principal, and Balances

1. Calculating Interest:
   • For instance, if balance brought forward is $2609.275$,
   • Interest calculation:
   • $Interest = 2609.275 imes 0.18$ = 469.67 (approximately)
2. Calculating Principal:
   • Principal = Cash Flow - Interest
   • Principal identified by amounts subtracted from the Cash Flow.
3. Balance Carry Forward:
   • New balances calculated as
   • New Balance = Balance Brought forward - Principal

Yearly Progression

• Transition of balances year by year as payments are processed:
  • Budgeting how the remaining balance continues to decrease annually with structured payments.

Ongoing loan calculations

• Establishing future years' payments based on first-year results, thereby creating a semblance of ongoing debts.

Conclusion & Recap

• Key takeaways include understanding the relationship between Cash Flow, Principal, Interest, and the presentation of the amortization schedule.
• Clarification on the importance of consistently tracking loan repayments to ensure accuracy and efficacy in personal finance management.