4.

3 Amortization Schedules

Let a loan be repaid with end-of-year payments of 1 over the next n years

the loan at time 0 (beginning of year 1) is:

an
an annual end-of-year payment of 1 using the amortization method will contain an
interest payment, It, and a principal repayment, Pt

1 = 𝐼𝑡 + 𝑃𝑡

a
Table 4.1: Amortization Schedule for a loan of n Repaid over 𝑛 periods at Rate 𝑖

Source: Kellison S.G. (2009)
Steps in constructing the amortization schedule:

Step 1:
Calculate the payment amount, 𝑅
Payment amount: 𝑅𝑎!|
###$% = Amount of Loan (PV)

𝑅=?

Step 2:
Interest Paid: Outstanding balance (year before) x 𝑖
Year 1: B0 x 𝑖
Year 2: B1 x 𝑖

Step 3:
Principal Repaid (for each year) = Payment Amount (for that year) – Interest Paid (for that year)

Principal Repaid as at 1st year: R1 – Interest Paid (I1)

Principal Repaid as at 2nd year: R2 – Interest Paid (I2)

Step 4:
Outstanding loan balance = Outstanding balance (year before) – Principal repaid (current year)
O/S balance (year 1) = B0 – [R1 – Interest Paid (I1)]
O/S balance (year 2) = B1 – [R2 – Interest Paid (I2)]

Repeat Steps 2-4 until the outstanding balance at the end of the term

To prove, add up 𝐼t + 𝑃t for that particular period, must equal to 𝑅

Other general formulas that can be used in constructing the amortization schedules at any point of
time, 𝑡 is as follows:

Interest paid:

𝐼& = 1 − 𝑣 !'&()

Principal Repaid:

𝑃& = 𝑣 !'&()

Outstanding Loan Balance:

𝐵& = 𝑎!'&|
#######
Example 3
Construct an amortization schedule for a loan of RM 1,000 to be repaid over four years at 8%

Steps in constructing the amortization schedule:

Step 1:

Calculate the payment amount, 𝑅

Payment amount: 𝑅𝑎*|

+ ,% = 1,000

𝑅 = 301.92

Step 2:
Interest Paid: Outstanding balance (year before) x 8%

Year 1: B0 x 𝑖 = 1000 x 0.08 = 80

Year 2: B1 x 𝑖 = 778.08 x 0.08 = 62.25
Year 3:
Year 4:

Step 3:
Principal Repaid (for each year) = Payment Amount (for that year) – Interest Paid (for that year)

Principal Repaid as at 1st year: 301.92 – 80 = 221.92

Principal Repaid as at 2nd year: 301.92– 62.25 = 239.67

Principal Repaid as at 3rd year:

Principal Repaid as at 4th year:

Step 4:

Outstanding loan balance = Outstanding balance (year before) – Principal repaid (current year)

O/s balance (year 1), B1 = 1000- 221.92 =778.08

Repeat Steps 2-4 until the outstanding balance at the end of the term (in this example the term is
4 years) is 0
For checking purposes:

To prove 𝑅 = 𝐼 + 𝑃 , let’s try with the example given above:

𝐼1 +𝑃1 = 80 + 221.92 = 301.92

𝐼2 +𝑃2 = 62.25 + 239.67 = 301.92

𝐼3 +𝑃3 =

𝐼4 +𝑃4 =

Amortization Schedule:

Year Payment amount Interest Paid Principal Repaid Outstanding

Loan Balance
0 1000.00
1 301.92 80.00 221.92 778.08
2 301.92 62.25 239.67
3 301.92
4 301.92
Total 1,207.68

Example 4
A RM1000 loan is being repaid by payments of RM100 at the end of each quarter for as long
as necessary, plus a smaller final payment. If the nominal rate of interest convertible quarterly
is 16%, find the amount of principal and interest in the 4th payment.

Question 1
A 35-year loan is to be repaid with equal installments at the end of each year. The amount of
interest paid in the 8th installment is RM 135. The amount of interest paid in the 22nd
installment is RM 108. Calculate the amount of interest paid in the 29th installment
4.4 Sinking Funds

• Alternative way to repay a loan – sinking fund method:

i) Pay interest as it comes due keeping the amount of the loan (i.e. outstanding
principal) constant
ii) Repay the principal by a single lump-sum payment at some point in the future

• Lump-sum payment, 𝐿: accumulated by periodic deposits into a separate

fund:called the sinking fund
• Has rate of interest 𝑗 (rate of interest earned on the sinking fund) usually different (and
usually smaller than, but could be the same) from 𝑖 (interest paid on the loan)
• If (and only if) 𝑗 is greater than 𝑖, then sinking fund method is better (for borrower) than
amortization method

There are two main important things to know before proceeding with the construction of the
sinking fund table:

i) The amount of the interest paid to the lender using the 𝑖 paid to the lender

ii) The amount of Sinking Fund deposit using 𝑗

Interest paid to the lender is calculated by: 𝒊𝑳

Sinking funds Deposit:

𝐿
𝑆𝐷 =
𝑆̅𝑛|̅ j

Steps in constructing the sinking fund schedule:

Step 1:
Calculate the interest paid to the lender, 𝑖𝐿 . The amount of interest paid to the lender will be
constant throughout the term of the fund.

Step 2:

Calculate the Sinking Fund deposit:

"
𝑆𝐷 = #
$$$%
"|
Step 3:
Interest earned on sinking fund: Amount in Sinking Fund (year before) x 8%

Step 4:
Amount in Sinking Fund = Sinking Fund Deposit (current year) + Sinking Fund Deposit (year
before) + Interest Earned (current year)

Step 5:
Net Amount of Loan = Net amount of loan (year before) – Sinking Fund Deposit (current year)
– Interest Earned on Sinking Fund (Current year)

Example 5
Construct a sinking fund schedule for a loan of RM 1000 to be repaid over four years at
8%.

Step 1:
Calculate the interest paid to the lender, 𝐼[ = 8% × 1000 = 80. The amount of interest paid to
the lender will be constant throughout the term of the fund (in this example, the term is 4
years).

Step 2:

Calculate the Sinking Fund deposit:

1000
𝑆𝐷 = = 221.92
𝑆*|
+ ,%

Step 3:
Interest earned on sinking fund: Amount in Sinking Fund (year before) x 8%

Year 1: 0 × 8% = 0

Year 2: 221.92 × 8% = 17.75

Year 3:

Year 4:

Step 4:
Amount in Sinking Fund = Sinking Fund Deposit (current year) + Sinking Fund Deposit (year
before) + Interest Earned (current year)

Year 1: 221.92 + 0 = 221.92

Year 2: 221.92 + 221.92 + 17.75 = 461.59

Year 3:

Year 4:

Step 5:
Net Amount of Loan = Net amount of loan (year before) – Sinking Fund Deposit (current year)
– Interest Earned on Sinking Fund (Current year)
Year 1: = 1000 − 221.92 = 778.08

Year 2: 778.08 − 221.92 − 17.75 = 538.41

Year 3:

Year 4:

Amortization Schedule:

Year Interest Paid Sinking Fund Interest Earned Amount in Net amount of
Deposit on Sinking Fund Sinking Fund Loan
0 1000.00
1 80 221.92 0 221.92 778.08
2 80 221.92 17.75 461.59 538.41
3 80 221.92
4 80 221.92

Question 2:

A borrower repays a loan by making annual interest payments to the lender at 7% and by making SF
deposits at 6% for 15 years. The borrower pays a total of $15,850 annually. What is the amount of
the loan?
4.5 Differing Payment Periods and Interest Conversion Periods

New interest, j must be calculated to be used in the calculation

Example 6
A borrower takes out a loan of $2000 for two years. Construct a sinking fund schedule if the
lender receives 10% effective on the loan and if the borrower replaces the amount of the loan
with semiannual deposits in a sinking fund earning 8% convertible quarterly.

𝑗, payment =
𝑖, interest =

Therefore, 𝑗 =

Interest on loan =

Then SD =

Year Interest Paid Sinking Fund Interest Earned Amount in Net amount of
Deposit on Sinking Fund Sinking Fund Loan
0
¼ 2000.00
½
¾
1 200.00
1¼
1½
1¾
2 200.00