Multiple Choice
Which of the following is a potential benefit of choosing a longer repayment period for a loan, such as 4 years instead of 2 years?
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10. Time Value of Money
Time Value of Money Equations
Multiple Choice
In a standard loan amortization schedule, what happens to the amount of principal paid with each successive payment over time?
A
The principal portion of each payment decreases over time.
B
The principal portion of each payment remains constant over time.
C
The principal portion of each payment increases over time.
D
The principal portion is only paid at the end of the loan term.
Verified step by step guidance1
Understand the structure of a standard loan amortization schedule: In a standard loan amortization schedule, each payment is divided into two parts—interest and principal. The total payment amount typically remains constant over time, but the allocation between interest and principal changes.
Recognize how interest is calculated: Interest is calculated on the remaining loan balance (principal). At the beginning of the loan term, the principal balance is at its highest, so the interest portion of the payment is also at its highest.
Observe the relationship between interest and principal: As the loan balance decreases with each payment, the interest portion of the payment decreases. This allows a larger portion of each subsequent payment to go toward reducing the principal.
Conclude the trend: Over time, the principal portion of each payment increases as the interest portion decreases. This is a key characteristic of a standard loan amortization schedule.
Verify the correct answer: Based on the explanation above, the correct answer is that the principal portion of each payment increases over time.
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