How to build an amortization schedule for a promissory note
An installment note says the borrower pays the same amount every month. It usually doesn't say how much of each payment is interest, or what the balance will be after payment 14. The amortization schedule answers both. Attach one to the note, and neither of you ever has to argue about the payoff number.
How amortization works
Each month, interest is charged on whatever balance is left. The payment covers that interest first, and everything left over reduces the principal. Because the balance starts high, early payments are mostly interest. As the balance shrinks, the interest portion shrinks and more of each identical payment goes to principal, until the last payment clears the balance to zero.
The payment formula
For a fixed-rate loan with equal monthly payments:
Payment = P × r ÷ (1 − (1 + r)−n)
- P is the principal, the amount borrowed.
- r is the monthly rate: the annual rate divided by 12.
- n is the number of monthly payments.
For $10,000 at 6% a year over 36 months, r is 0.06 ÷ 12 = 0.005 and n is 36. The payment works out to $304.22. A spreadsheet's PMT function gives the same number, and so does our loan payoff calculator.
Worked example: $10,000 at 6% for 36 months
Each row takes the balance, multiplies it by 0.005 for the month's interest, and subtracts that from $304.22 to get the principal paid.
| Payment | Amount | Interest | Principal | Balance after |
|---|---|---|---|---|
| 1 | $304.22 | $50.00 | $254.22 | $9,745.78 |
| 2 | $304.22 | $48.73 | $255.49 | $9,490.29 |
| 3 | $304.22 | $47.45 | $256.77 | $9,233.52 |
| 12 | $304.22 | $35.66 | $268.56 | $6,864.06 |
| 24 | $304.22 | $19.10 | $285.12 | $3,534.68 |
| 35 | $304.22 | $3.02 | $301.20 | $302.67 |
| 36 | $304.18 | $1.51 | $302.67 | $0.00 |
Over the 36 payments the borrower pays $10,951.88 in total, so the interest on the loan is $951.88. The last payment is four cents lower than the rest because each month's interest is rounded to the cent. Most schedules settle that difference in the final payment.
Interest-only and balloon notes
Not every note amortizes. An interest-only note charges just the interest each month, so the balance never moves and the full principal is due at the end. On the same $10,000 at 6%, that's $50.00 a month, and $1,800 in interest over three years, almost twice the amortizing version. A balloon note amortizes part of the loan, often on a longer schedule than the actual term, and leaves a large final payment. See balloon payment notes and demand versus installment notes.
When the schedule stops matching
A schedule assumes every payment arrives on time and in the exact amount. Extra payments applied to principal shorten the loan, and late or partial payments add interest. Once that happens, recalculate from the actual balance, or better, keep a running ledger of real payments next to the original schedule. The note should say whether extra payments go to principal. See keeping a payment ledger and paying off a note early.
Putting it in the note
- State the payment amount, due date, and number of payments in the note itself.
- Attach the full schedule as an exhibit and have both sides initial it.
- Say the interest is simple and fixed, and how extra payments are applied.
- Check the rate against your state limit and, for family loans over $10,000, the IRS applicable federal rate. See how to calculate interest.