Improve Student Understanding of Amortized Loans

Abstract

Amortized loans, such as mortgages and auto loans, are common real-world examples introduced in the first finance college course. Many students mistakenly believe that the monthly payments on an amortized loan should be larger than the monthly equivalent of the annual payments (the annual payment divided by 12) of the same loan. This paper mathematically demonstrates that the monthly payments must, in fact, be smaller than this monthly equivalent. Also, the paper shows a loanee does pay more interest with monthly payments. Furthermore, this paper presents an alternative approach to treat amortized loan payments as investment or an opportunity cost, thus improving student understanding of amortized loans and financial decision-making.