Principles of Finance, August 2010, Mortgages
Basics of mortgages and amortization schedules.
Before we start building a spreadsheet, it’s useful to get some background.
Learning about mortgages is probably the most useful thing you will learn in FIN
Almost all of us envision owning a house some day, not to mention that
some of us may already.
And, unless you are filthy rich, you will need a
The first thing to understand about a mortgage is the amortization schedule.
you probably know, a mortgage requires a monthly payment that does not
change (for a standard fixed-rate mortgage, that is).
We calculate this payment
using our financial calculators.
This payment is used to pay the interest we owe
each month, along with paying off part of the mortgage.
It is designed so that the
balance on the mortgage will be zero when we have made our final payment.
Let’s see an example and how the calculations are done, using the following
The Jordan family recently purchased their first home.
The house has a 15-year
(180-month), $165,000 mortgage.
The mortgage has a nominal interest rate of
All mortgage payments are made at the end of the month.
What is the
monthly payment on the mortgage?
To calculate the monthly payment on the mortgage using a financial calculator,
the following steps will accomplish the task:
P/Y = 1
PV = 165,000
N = 180
I = 7.75 / 12
FV = 0
CPT PMT = 1,553.10
So, we know we need to send our lender $1,553.10 each month, but what does
That is what an amortization schedule is for.
schedule is setup as follows:
For each month, we want to know what portion of the $1,553.10 goes toward
What’s left goes toward principal – that is, repayment of the loan.
To calculate the interest portion, we multiply the monthly interest rate by the