When we discuss loans, the borrowed amount is the loan principal. The principle is used as a basis to calculate the interest. The latter is separated from the principle in an amortization schedule. Thus it becomes evident which of the client’s monthly payments is due for the repayment of interest and which goes for the principal. The payment of the due interest does not reduce the principal.
A loan is a service and as such, it has a value. In view of its nature, the loan is granted in return for a reward. For the long term capital investments , the borrowed money is repaid with monthly, semi-annually, or annually. The calculation of these payments is performed in several ways:
- Equal payments per time period – amortization;
- equal payments of the principal over a period of time;
- equal payments spread over a particular time period with a quoted payment at the end which is due to close the balance. The last is also known as the balloon payment.
When the first method is used, the accrued interest is included in each payment, calculated only on the unpaid balance. Then, a part of the principle is added. With each payment, the amount of the principle which is applied to the payment increases.
The method which uses the equal payments principle also includes the unpaid balance of the accrued interest, plus an equal part of the principle. The payment due diminishes as the remaining balance of the principle also declines. The amount of the interest which is due also decreases because it is calculated over the principal.
The two plans discussed above are the most common methods applied for the computation of loan payment on long-term investments. In addition, it is possible for the lenders to use the balloon system in order to decrease the size of the periodic payments.
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