Loan Types & Loan Amortization

• Source of obtaining funds for your personal or business purposes
• Large sum of funds can be obtained without having to save for them in advance
• They can be adjusted to suit the needs of the individuals or businesses
• Flexible terms and conditions can be negotiated for the repayment purpose

These loans types are exactly the opposite of secured loans. They are not provided against any asset as security. Such loan grants are however provided keeping in view the credit history of the client at the time of loan application. Apart from credit history, the client's evaluation procedure also includes verifiable income flow, existing assets and already taken loan facilities. Since there is much risk associated with unsecured loans as they are not backed by asset security, therefore the lender charges high interest rates.

Examples include the following set of loans:

• Personal loans
• Personal lines of credit
• Educational loans
• Credit cards

Whenever a loan is granted to a borrower, some provisions will always be set for the repayment of the principal amount (original loan amount) and the interest amount (lender's profit). Let's analyze a few simple forms of repayment that you might often come across. However, more complicated forms can emerge from such simple forms of repayment that I will be discussing in detail.

There are three basic types of loans categorized based on repayment schedule:

• Pure discount loans
• Interest only loans
• Amortized loans

Pure discount loans have the simplest form of repayment method. In such loans the borrower gets the money today and repays a lump sum of money by the end of the loan term without having to pay periodic interest payments. Treasury bills are the best example of a pure discount loans.

Suppose a person promises to repay $20000 with a 10% interest for one year period. The lender would definitely want to know how much it worth's today. For that purpose lender can find the present value of such an investment.

Present value can be calculated using a financial calculator or MS excel.

 Future Value = $20,000 , Interest Rate = 10% , Number of Years of Loan term = 1

Calculated:  Present Value = $18,181.82

The greater the difference between the present and future values, the more attractive the investment will be for the lender.

Interest only loans call for interest payments being made by the end of each period while repaying the principal amount by the end of loan term. It is very evident if you have an interest only loan for just one period in such a case the interest only loan and pure discount loan will be same thing.

Suppose a person has taken an interest only loan of $20,000 with a 10% interests for three years period. Assume that the payment is on annual basis. 

Calculation: Interest Payment = 20,000 (0.10) = $200

This means the borrower will be required to pay $200 each period and a lump sum of principal when the loan term expires. The last year repayment of borrower will include the interest payment of $200 in addition to the $20,000 principal amount.                     

Amortized Loans are alternate option for the interest only loan. In such loans the borrower repays a portion of the principal amount along with interest payments by each period of the loan term.

The word amortization describes the process of paying of the loan by making regular principal reductions.

The below Amortization schedule clearly indicates the by the end of loan term the ending balance becomes $ 0.00. For illustration purposes I have chosen the annual payment to just keep the calculation simple.

Example: A loan of $20,000 is taken on annual basis payment in arrears with a interest rate of 10% and is required to be paid off over a period of 5 years. 

Note: Arrears means ending mode.

If you are finding it difficult doing all the amortization calculations then you might prefer trying the Amortization table guides provided below. They will navigate you to choose the perfect home loan option that suits your requirements.