Accounting Transactions:
What is Amortization?

If you buy a home, become a banker, or deal in the financial industry, amortization will not be a large part of your daily vocabulary.  But, if you're an accountant, and choose one of the careers listed above, you're going to need to understand this term.  You really are going to need to know how to use it to your advantage, also.

Amortization is defined as the way to reduce debt by installments.  In other words, we reduce the amount of our obligations by making monthly payments against the debt.  Mortgage payments are an amortization of our loan made to purchase our home.  So, if you purchase a home, you will need to understand amortization, as well.

When the debt you incur is much larger than can be paid within a few weeks or months, lending institutions "amortize" the loan; that is, they calculate equal monthly installments that are designed to provide you with payments that take care of the debt plus the interest charged for the use of the lending institutions money while you repay the debt. I'll bet you didn't realize the whole point of that nice offer, was to charge you interest, uh? Today, there are so many ways that lending institutions have created to help people purchase homes, businesses, and other major items, that amortization is like an artist's canvas, open to creativity.  Interest only loans, balloon notes, and adjustable rate mortgages mean that amortization tables of all kinds are in use today.

What does this mean for the borrower?  The amortized debt may be excessive, and you may pay more in interest than you actually paid for the item purchased.  In Latin "mort" means death; today, amortization associated with mortgage loans is a double whammy.

Amortization also applies to the tax accounting functions and the use of depreciation.  The use of depreciation in computing the income tax liability for businesses is a big issue; amortization of loans and interest paid is an even bigger one.  Since all interest on business loans is deductible for the business, understanding the equilibrium point for business benefit is important if you're going to provide the accounting services for a growing business.

Home mortgage interest is also often deductible for couples or individuals who buy homes, but here again: there is an equilibrium point, at which the benefit ceases.  The more you understand about amortization tables, calculated periodic payments, and debt, the better equipped you are to survive the amortization process, profitably.

If you're a child of the baby boom generation, you've become well acquainted with amortization, and the interest that is included with the amortization of debt.  If you're of a younger generation, get ready to become acquainted.  The generation of the Great Depression knew a few things about repaying debt, and the consequence of a drastic loss of income versus amortization.  Sometimes, in a society, an overuse of an opportunity exists.  I'm afraid we're only a generation (or less) away from overuse of the process known as amortization!

Information is for educational and informational purposes only and is not be interpreted as financial or legal advice. This does not represent a recommendation to buy, sell, or hold any security. Please consult your financial advisor.