In this screencast, you're going to learn all about something known as amortized loans. In the previous screencasts, there's actually two screencasts, part 1 and part 2, we looked at how we can borrow a lump sum of money and pay it all back in one lump sum, or you can invest a lump sum of money and take it all out of the bank at a later point in time as one lump sum. In either case, no payments were made in those examples, and no disbursements were taken. Our disbursement is basically a withdrawal from a bank account. For example, a savings account. Payments and disbursements are known as annuities. That term annuities is more common when we talk about payments, but we can also take payments from a savings account. Amortized loans, which we're talking about in this screencast, allow us to make payments towards the loan amount, also known as the principal, to gradually pay it off over a period of time. So in the previous screencasts, we considered a loan amount, so we have some principal that's the original loan amount, and over time, that loan amount earns more money, it earns interest. The combination of the principal plus the interest is known as the future value. If you took a lump sum loan amount and a couple years later or months later, the end of the loan, you would have to pay back all of the future value in one lump sum or one payment. But what if we make small loan payments over time? We start with our original loan amount and after the first month it has earned interest, and then we might make a monthly payment. That monthly payment is sufficiently larger than the interest, and so we draw down the interest that has been earned and we also pay off some of the principal, and so after one month we might have this amount. In the second month, we earn more interest, that interests is a little bit less than the first month because the principal has been paid down a little bit. We make a monthly payment, that monthly payment pays off the interest that has been earned in the second month and it also pays off some of the principal, and so the principal keeps going down. The third month, we earn interests, we make a payment. Over time, we slowly pay down or reduce the principal. So for example, after eight months we might have this amount of principal, we earn a little bit of interests in that eighth month and we make a monthly payment. That final monthly payment might cover both the interest and the remaining principal, and so at this point, the loan is paid off. These are known as amortized loans. We have payments where part of each payment goes to the interest and the rest of that payment goes to paying down or reducing the principal. There are three things of interest, when we're talking about amortized loans. First is the present value, also known as the principal, so that's the loan amount. We want to know the future value, what the loan or savings will be worth in the future. If you're trying to pay off a loan, the future value, you want that to be zero. So a lot of times the future value's going to be zero. You also need to know the payments, the amount of the payments that are made, or for savings accounts, we'll talk about this in a subsequent screencasts, we have to know that the amount of the disbursements that are taken. In Excel, in order to look at amortized loans, we need two of the three variables above in order to calculate the third. Oftentimes, one of these two variables will be zero. Again, if you're paying off a loan, you want the future value to be zero, we can use these common functions in Excel, the future value function, FV, the present value function, PV, and the payment function. The future value function requires present value and payment, present value function requires future value and payment, the payment function requires present value and future value. We have three functions here that all depend upon one another. Just as a reminder, the future value function calculates the future value of an investment based upon a rate, the number of payment periods, the payment made each period, and the present value and so the default is zero. Oftentimes the type that we use, the last argument is zero for payments that are due at the end of period, because that's typical of financial institutions. The present value function is similar, but it calculates the present value of a loan or investment. Both of these future value and present value functions were covered in part 1 of the course. Finally, we have the payment function that we can use in Excel. If we know the future value and we know the present value, we know the rate and the number of payment periods that we want to have, then we can calculate the payment. So how much do we need to pay each month in order to pay off our loan? That's basically it for setting up amortized loans. The subsequent screencast are going to show you examples and how to implement these Excel functions to work with amortized loans. I'll actually be showing you how to set up an amortization schedule to use with these amortized loans.
