The granting of a loan by a bank or other financial market operator is in all respects a contract and as such it must regulate relations between the parties concerned. For this reason, the contracting phase of the contract is fundamental for understanding what the conditions will be that will then be applied to your loan. The clauses to which the maximum attention should be shown are essentially two, the interest rate applied and the loan amortization plan.
The first consists in indicating what the cost will be incurred, for the applicant, to obtain the advantage of having the established sum, for the period he needs. The loan amortization plan, on the other hand, represents the lifeblood of the loan, in fact it serves to regulate all future debtor relationships between the applicant and the issuing institution. It consists of a detailed list of the installments to be paid, the precisely calculated amounts and the methods for making these payments.
The loan amortization plan: what it is?
When calculating the loan amortization plan, you must first determine which model is authorized. The latter is almost never used and for this reason we will not treat it, it is mostly a school case of little practical relevance.
What basically differentiates them more markedly is the consistency or otherwise of the installment to be paid. Let’s see this point in detail. Let’s start with the amortization of the loan with an calculation, even if it is undoubtedly less used than the other. Basically, this typology is characterized by the constancy of the capital shares of each single installment.
The loan amortization plan: the installments
The installment consists of a portion relating to the principal to be repaid and an interest portion. The interest rate is always changeable as it must allow the bank to re-enter the value of the same in the first years of the amortization period. It is quite clear that the first installments will, with this method, be higher than the last installments which will have a smaller amount due to the low incidence of the value of the interests on the total debt.
This asymmetry of the installments is due, as already mentioned to the interests but we try to understand better. The bank will have the advantage of collecting this amount first as it would risk losing part of it if the loan is canceled early. The residual capital portion, on the other hand, can be repaid even later as it must, in any case, be returned to the creditor’s coffers. Now let’s analyze the loan amortization plan with the French method, that is the one most used in our economic and financial system.