Updated on May 5, 2015 by Cherry Vi Saldua Castillo 7 Comments
Knowing your monthly amortization payments is a very crucial factor in knowing whether you will earn passive income from your real estate investment or not.
In a nutshell, your monthly rentals should be greater than your monthly amortization payments and all other expenses for you to have positive cash flow and passive income.
Many people know what amortization is, but there are also many who hear about it all the time, but don’t really understand it, and are too shy to ask, what is amortization?
What is amortization?
In simple terms, amortization is the amount a borrower pays monthly to pay off his debt to a lender. The amount loaned is called the principal while the payment to the lender for the use of his money is called interest. The monthly amortization is a constant amount which is composed of payments for both interest and principal.
How is interest computed?
The interest is computed based on the diminishing balance of the principal loan amount. Diminishing balance means that the principal loan amount becomes smaller each time a portion of the principal is repaid.
How is the amortization divided between principal and interest?
Since the interest on the loan is usually on the diminishing loan balance, and the amortization amount is constant, a bigger portion of the amortization goes to interest compared to the principal during the early part of the loan term because the loan balance is still big at that time.
There may be times during the early years of the loan term that you may think that
you have been paying for so many years already but when you look at the loan balance, only a small portion of the principal has been paid.
In contrast, during the latter part of the loan term, a bigger portion of the amortization will be going to the principal since the interest will be lower due to the already diminished loan balance.
How is the monthly amortization computed?
The formula for monthly amortization is:
For example, you want to buy a property priced at Php 1 Million. The downpayment is 20%, and the payment term is 20 years at an annual interest rate of 11.5%. What would be the monthly amortization you need to pay?
First, determine the Principal amount. Since the selling price is Php1,000,000 and the downpayment is 20% or Php200,000, the loan amount would be:
=Php1,000,000 – Php200,000
Next, get the amortization factor. In the example, the payment term is 20 years and the annual interest rate is 11.5%. The amortization factor, based on the corresponding Amortization Factor Table. is 0.0106642963 .
*Check our complete list of amortization factors through this link: Amortization Factor Rates
Since you know the principal amount and the amortization factor, you can now compute the monthly amortization payment:
Monthly amortization = Php800,000 x 0.0106642963
How is the amortization factor computed?
If you don’t have internet access and you have a calculator, or you simply want to calculate manually, the formula is as follows:
I = the monthly interest rate or annual interest rate divided by 12
M = the loan payment term in months