When...you repay a loan...over time on your own...that’s amor...tization…
Amortization. Big word. We’ve got the root word “mort” in there…which means “death"...and yeah, when you’re amortizing a loan, you’re...killing it. Softly. With your song. You’re gradually reducing your obligation by paying back whatever you borrowed. So that, once a loan is fully amortized, the amount you owe is...zero.
That’s one definition of the term. It’s also a fancy way of saying “allocate costs." The same process of slow killing (metaphorically that is) applies to other financial situations.
You pay a thousand dollars for an amazing bed. Did you get value from it? Well, if you USE it a lot, you’ll AMORTIZE the costs in such a way that the bed is…cheap. How so? Well, if you sleep on it for 2,000 nights before you toss it, you’ve paid 50 cents per night for your bed. That’s like a nickel an hour of use. And that assumes it’s just you in the bed. Giggity.
What about a prom dress or tux? Well, the finest Walmart prom dress runs about 300 bucks. But you wear it once before Tyler Hendricks vomits on it and…then you’re done. So it cost 300 bucks a night, or about 50 bucks an hour, for the 6 hours you wore it. Way expensive per use because you only had 6 hours of amortization.
Loans work the same way. You borrow 120 grand to buy a home with a 30-year mortgage. Over those 30 years, you amortize the loan, or allocate the paying-down of that $120k you just borrowed, over a long period of time. So...something to keep in mind the next time you go shopping for a bed...or a dress.
It also works when applying amortization to the process of assigning costs or revenues across time. Example: You license one year of house-sitting duties on an as-needed basis for $1,200. You are paid all $1,200 up front. But you might be fired after 3 months. Or you might quit after 9. You amortize the value of that contract as $100 a month over the life of the license.
Related or Semi-related Video
Finance: What is Bond Amortization?7 Views
Finance a la shmoop what is bond amortization? okay fancy term easy
concept the basic idea is that you have to "revalue" what a bond is
actually worth each period which usually means twice a year because bonds pay [Monthly calendar appears]
interest on the you know semester system yeah twice a year so let's say you've
paid seven hundred bucks for a bond with a 5% coupon which comes due for a
thousand bucks in ten years over that time you'll have received two things the
5% per year interest from the bond in cash paid along the way and the [5% interest per year appears]
appreciation of the 700 bucks to become the thousand dollar par value at which
point it will eventually pay back its principal so to amortize the $300 of
appreciation of that bond over ten years while you could attribute 30 bucks a
year in appreciation each year such that after we'll say three and a half years
you'd hold the bond as having appreciated 3.5 times 30 bucks or $105 [Straight line appreciation formula appears]
in appreciation making the bond worth at that point in time eight hundred five
dollars oh yeah fancy but also pretty easy
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