What loan is repaid with periodic payments of both principal and interest?
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Borrowers feel the pinch from the moment they take out a loan. That's why it's key to figure out your loan payments before rather than after you take out a business loan. Show
Not sure where to start? Keep reading for a walkthrough of how to calculate loan payments for two common types of loans. Amortizing vs. interest-only loan paymentsThe type of loan you plan to take out will dictate how you calculate loan payments. Generally speaking, there are two common types of loans are the amortizing and interest-only. Let's start with the standard amortizing loan. You would pay down both the principal and interest on a gradual basis until you pay off the whole loan. You would make fixed periodic payments over the life of the loan. Lenders view these loans as low-risk because they get back a part of the principal with each loan payment. It's also easier to budget for these loans because you pay the same amount during each period. With an interest-only loan, you pay down the interest until the loan matures. At that time, you pay off the principal as a lump sum. The delayed principal payments might seem like a benefit to cash-strapped business owners. But lenders view these loans as riskier. This is because the borrower does not pay back the principal until late in the borrowing period. You might also find it difficult to budget for the sudden rise in payment resulting from the lump sum. A lack of proper budgeting can lead to the inability to repay the principal. How to calculate amortizing loan paymentsUse the following formula for how to calculate loan payments on an amortizing loan. A = P({i[1+i]^n} / {([1+i]^n)-1}) Where: A is the periodic payment amount P is the principal or the original loan balance, less any down-payments i is the periodic interest rate. To calculate i, divide the nominal annual interest rate as a percentage by 100. Divide that figure by the number of payment periods in a year. n is the total number of periods. To calculate n, multiply the loan duration in years by the number of payment periods in a year. Let's take a look at an example of an amortizing loan repaid on a monthly schedule. Say you want to take out a 5-year, $25,000 loan at a nominal annual interest rate of 6 percent. P is $25,000 i is .005 ({6/100} / 12 months in a year) n is 60 months (5 years * 12 months in a year) Your monthly loan payment would be approximately $483. Here's the math: A = 25,000({.005[1+.005]^60} / {([1+.005]^60)-1}) A = 25,000(0.00674425076 / 0.34885015254) Loan Payments = $483.32 How to calculate interest only loan paymentsThe formula for how to calculate loan payments on an interest loan is simpler. A = Pi Where: A is the periodic payment amount P is the principal or the original loan balance, less any down-payments i is the periodic interest rate. To calculate i, divide the nominal annual interest rate as a percentage by 100. Divide that figure by the number of payment periods in a year. For example, let's say you want to borrow the same $25,000 through a 5-year interest only loan at 6 percent interest. Your monthly loan payment would be approximately $125. Take a look at the math: A = 25,000*.005 A = $125 The interest part of the loan payment would continue at this amount. But you would still have to pay off the principal at loan maturity. How to calculate loan payments with an online calculatorIn like manner, web-based loan calculators can help you determine your loan payments without math. Examples include Bankrate's amortizing and interest only loan payment calculators. Your lender may offer a similar calculator on its website. The calculator outputs your periodic payment amount when you input the terms of the loan. What is Loan Structure？Companies borrow money from banks or other financial institutions for a variety of purposes. They might need additional working capital, for example, or wish to purchase new equipment, pursue expansion plans, acquire another company, or meet unexpected expenses. A borrower repays the loan with interest over a predetermined period called the term of the loan. Loan structure refers to the constituent parts of the loan, such as the purpose, amount, type, interest rate, repayment term, and repayment method. The structure also includes measures to mitigate risk, and may include requirements for a guarantor or other covenants. The structure is based on factors including the purpose of the loan, the borrower’s risk profile, and the repayment period. A loan application will only be approved if the loan structure enables the borrowers to achieve the intended purpose, and all of the loan terms are acceptable to both the borrower and lender. Key Learning Points
Considerations in Structuring a LoanLoan structuring focuses on the loan type (fixed or adjustable) and product (conventional, government or jumbo), the amount of loan, the closing costs, the loan term, collateral, guarantees, interest rate, and repayment schedule. Loan Amount (Principal)The amount of the loan is the crucial element in the structure, as it must be sufficient to meet the borrower’s needs while reasonable. The right loan product can save the borrower money, as differing products may entail different fees and interest rates. Loan TermThe term of a loan is the length of time between the loan’s origination and the maturity date. Borrowers need to determine maturity based on whether the funds are to be used for emergencies, one-time situations, or investment in expansion or other long-term business goals. Interest rateInterest rates depend on many factors, including the total amount borrowed, the length of the repayment period, the lender, the type of loan, the borrower’s financial profile, and collateral. For example, a borrower with a lower credit rating will be required to pay a higher rate of interest. Understanding loan costs can put borrowers in a stronger position to choose the best option and save on interest and fees. RepaymentLoan repayment involves setting periodic payments that consist of both principal and interest over the loan’s term. A portion of each payment is used to cover interest charges, while the remainder reduces the loan’s principal balance. CollateralCollateral is a tangible asset or collection of assets belonging to the borrower that is pledged as security for the loan. Should the borrower default, the assets become the property of the lender? In structuring term loans, lenders should not only consider the value of the collateral but pay close attention to the historical and expected cash flows from the main source of repayment. Benefits of Good Loan Structuring
Loan Structure ExamplesFor example, commercial term loans are typically available for up to $600,000, with repayment periods ranging from one to five years and expected interest rates ranging from 7% to 30%. The term loan process is faster and less demanding than traditional bank loans and can be used for a variety of purposes. Therefore, term loans are good options for business owners who want to invest in a specific business segment or have an ongoing working capital need. A loan can finance a real estate purchase, business acquisition, renovation, or expansion. For business owners who want a flexible form of financing to meet more immediate funding needs in case of cash flow gaps or emergencies, a business line of credit is more suitable. A business line of credit is typically up to $250,000 with an interest rate of 7%-25% and a term of up to 2 years. Example of Simple Loan Payment CalculationYou are considering applying for a $10,000 loan that will be repaid with equal end-of-month payments over the next 48 months. If the annual interest rate for the loan is 6.5%, how much will your payments be? Answer: The size of the monthly payment can be determined by inputting values for the three known variables and computing PMT. N = 48; I/Y = 6.5%/12; PV = 10,000; PMT = $237.1 Calculation using excel is shown below: Access the workout to practice more simple loan payment calculations, and access the full file to check your answer. ConclusionLoan structure is generally determined by the purpose of the loan, the repayment ability of the borrower, the cash flow, and the useful life of the assets purchased with the loan. From an investor’s point of view, loan structure is very important. Borrowers should actively structure loans to maximize business profitability. A reasonable loan should benefit both the borrower and the lender. Explore what you need to know to succeed at credit analysis with our online credit analyst course. The course covers credit analysis for lenders, cash flow modeling, and distressed debt restructuring. Additional ResourcesModeling Ratios Covenants Loans Asset Backed Loans Is the periodic payment of the principal and interest on a loan?Periodic payment is the scheduled payment due each period and includes interest, principal, taxes, and insurance. If the payment is due monthly, the periodic payment is generally called the monthly payment.
What is the name of periodic loan payments that pay back the principal and interest over time with payments of equal amounts?Amortization: Loan payments by equal periodic amounts calculated to pay off the debt at the end of a fixed period, including accrued interest on the outstanding balance.
What type of mortgage requires the payment of periodic installments of principal and interest?An amortized loan requires fixed, periodic payments that are applied to both the principal and interest until the loan is paid in full. Expect to pay more in interest than principal during the start of your loan, then that reverses toward the end of your loan.
Which type of loan will be paid off in full both principal and interest at the end of the loan's term?Fully amortized loans have schedules such that the amount of your payment that goes toward principal and interest changes over time so that your balance is fully paid off by the end of the loan term.
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