Essay Example on Monthly Interest Beats Annual: Compounding for Better Returns

Introduction

The monthly interest payment is better than annual interest payment. Better returns on savings are realized when there is regular compounding. Regular compounding has an interest which is credited into the principal balance frequently, thereby making the interest to begin earning its interest immediately (Donald, 2016). The key concept here is the interest that is earning interest. The accounts compared are of a similar nominal yield with similar deposit and time. Nominal yield refers to the yield on deposit, and it is used in calculating interest. It is different from the annual percentage yield (APY), that helps in calculating the rate of compounding that increases the effective yield. More imperatively, the saving Act requires financial institutions to give the APY on deposit to enable people who save in making easy comparisons.

Is your time best spent reading someone else’s essay? Get a 100% original essay FROM A CERTIFIED WRITER!

Save 25%

Amortization Schedule

The amortization schedule is a table of data which illustrate the process that is followed while paying off loans, and it contains all the details for each payment. The amortization schedule provides loan balance, the interest on loans and the principal amount every month (Uno, 2015). The schedule assists in understanding the way loans work, and it can help in approximating the outstanding and cost of interest in future. The purpose of the amortization schedule is to help in evaluating whether to pay off the debts early or later, the costly loan in the long-run and if borrowing is good or bad. The items in the data table include; schedule payments which indicate monthly payment. Interest expense is the monthly cost on loan borrowed. Principal repayment comes after interest charges have been applied and the balance goes to payment of the debt. Notably, the loan balance reduces over time as it moves through the amortization schedule.

Interest on Home Mortgage

Mortgage payment comprises of principal payment and interest, and the proportion of interest to the principal payment changes over time. A home mortgage is a basic interest initially, with a little amount of principal added. The principal portion of payment increases with the maturity of the mortgage, thereby decreasing the interest portion. The reason for that is because, the cost of interest is determined based on the current outstanding mortgage balance that reduces with more payment on principal (Spedicato, 2013). More significantly, the little the mortgage principal, the smaller the amount of interest charged. Despite the monthly decrease in interest, the mortgage does not reduce with time. More is taken to the principal balance that is amortized within the duration of the loan. Consequently, more of the home mortgage payment move towards the principal as the time increases. Therefore, it is better to pay interest in the early years of the home mortgage than later.

Ordinary Annuity and Annuity Due

Ordinary annuity refers to the order of a steady cash flow, where both payments and receipt are made at the end of every period. While in annuity due, the payment and receipt are made at the beginning of every period. In an ordinary annuity, every inflow or outflow has to relate with the period which is preceding its date, while in annuity due, the cash flow duration, which follows its date (Spedicato, 2013). And the cash flow in the annuity due happens a period before the ordinary annuity. An ordinary annuity is appropriate when payment is being made, while annuity due is good when payment is being collected. Ordinary annuity includes the mortgage payment, car loan and the coupon-bearing bond, while annuity due includes car payment and rental lease.

References

Donald, D. W. A. (2016). Compound interest and annuities-certain. Cambridge University Press.

Spedicato, G. A. (2013). The lifecontingencies Package: Performing Financial and Actuarial Mathematics Calculations in R. Journal of Statistical Software, 55(10), 1-36.

Uno, T. (2015, August). Constant time enumeration by amortization. In Workshop on Algorithms and Data Structures (pp. 593-605). Springer, Cham.