For those of you who have loans like auto and/or mortgages, you are using an amortization schedule to pay your loan off.  What it means for most of us is that you’re slowly paying off debt and spreading out the cost of your asset over a predetermined timeframe.  And, an amortization schedule breaks down your principal and interest payments by month.  It shows how much principal and/or interest you’re paying over time each month.

I’m going to use a mortgage as an example.  You pay off your principal and interest over a prescribed amount of time.  The actual payment amount will stay the same.  However, with each payment, your interest obligation gets smaller because it’s based on a lower loan balance.  The principal you pay each month increases because you’re paying less in interest.  Those two items always have to equal your payment amount.  It may only be a dollar or two in the beginning, but both principal and interest amounts will change monthly.  Auto loans use the same methodology.

For example, you’ve just purchased a new home for $300,000 and put $50,000 down.  Your loan is now for $250,000.  You’re paying 6.25% interest on the loan for 30 years.  Without taxes and insurance, your payment is $1,539.29 every month for the life of the loan.  Out of that payment, for your first month, you’ll pay $1,302.08 towards interest and $237.21 towards principal.  For your second payment, you’ll pay $1,300.85 towards interest and $238.44 for principal.  At the start of year two, you’ll pay $1,286.83 towards interest and $252.46 towards principle.  The balance on the loan would be $246,818.04.  Over the life of the 30 year loan, you’ll pay a total of $304,145.48 in interest.

Moral of the story:

I hope you can see how an amortization schedule works.  It basically shows you how much of each payment is going towards your principal and how much towards interest.  Tomorrow, in part 2, I’ll show you what happens if you round up your payment, just a little and how it affects your bottom line.