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## Answers

Jim SchwartzTitle:Corporate financial advisorCompany:Wabash Financial StrategiesYou are on the right track. You have described a 28 month loan with an interest rate of 20.04% annually and monthly payments of $325, which I have assumed are made in arrears (i.e., at the end of each month).

[Note that "principle" is a truth or belief. The balance on a loan is the "principal."]

After payment one, you correctly determined the remaining principal balance as $6874.07. You do not "calculate the interest on that $100" partial payment though. Instead, as you did, determine the interest for one month on the then-remaining principal balance ($6874.07 x 0.2004 / 12), or $114.80. In the assumed case where the actual payment was $100, add the $4.80 interest shortfall to the remaining principal balance. The result is a revised principal balance of $6878.87. This is an example of negative loan amortization.

Because the principal has not been paid as expected, either the amount or number of remaining payments will need to be adjusted in order to recover the full loan amount and the agreed yield. In this case, the interest portion of the next monthly payment (#3) would be $114.88 ($6878.87 x 0.2004 / 12). The difference between $114.88 and the actual payment would be applied to reduce or increase, as above, the remaining principal balance.

In many loan contracts, there is a provision for late charges, an additional amount to be assessed when payments are made late or for less than the full amount. Such charges are intended to compensate the lender for the extra work and additional risk (both credit risk and interest rate risk) of having a larger than expected loan balance and/or longer than expected loan term.