Amortisation (DP IB Applications & Interpretation (AI)): Revision Note

Amortisation

What is amortisation?

• Amortisation is the process of repaying a loan over a fixed period of time

  • Most commonly questions will be about mortgages (loans taken out to buy a home) or loans taken out for a large purchase

• Interest will be paid on the original amount

  • Each repayment that is made will partly repay the original loan and partly pay the interest on the loan

  • As payments are made the amount owed will decrease and so the interest paid will decrease

    • As you continue to repay a loan more of the repayment goes on the loan and less on the interest

How can the GDC be used to make calculations involving loans?

• Your GDC should be used to solve questions involving loans

  • Use the finance solver mode (sometimes called the TVM (time value of money) solver)

    • N will be the number of repayment periods (remember to include months and years if necessary)

    • I (%) is the interest rate

    • PV is the amount that was borrowed at the start – as this has been received it will be entered as a positive number

    • PMT is the payments made per period – this is repaying the loan so will be a negative number

    • FV is the future value (this will be zero as the loan will be paid off at the end of the period)

    • P/Y is the number of payments per year, usually 12 as payments are made monthly

    • C/Y is the compounding periods per year

    • PMT@ is the time of the year or month the payment is made (assume this is the end unless told otherwise)

  • Leave the section that you need to find out blank and fill in all other sections

  • Your GDC will fill in the last part for you

• It is sensible to check your final answer, you can do this by finding the total amount paid back overall and comparing it to the original loan

  • The total amount repaid will be a little more than the original loan plus I % of the original loan