Amortization of Long-Term Debt

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Amortization of Long-Term Debt
Loans are amortised to divide them into payments. (form -3 image by Rog999 from Fotolia.com)

Long-term debt must always be amortised, but the methods and reasons can differ. For instance, businesses that have long-term debt--the borrower--often amortise their loans out as part of their accounting procedures, to make sure they have enough money to pay off the loan. Lenders such as banks will amortise long-term loans to see how they will realise profits on the loan, and to show the borrower how the loan must be paid back.

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Long-Term Debt

Long-term debt is typically any debt that lasts longer than one year. If the borrower does not pay off the debt in a year, it is considered long term from an accounting perspective. Many different bonds and other security notes, are long term. Other types of loans, often made by large lenders for major business undertakings, are considered long-term loans because of the time invested in the project and the years it takes to pay the loan off.

Interest Rates

Interest rates are an integral part of loans and most important for long-term loans that will come due at a period years in the future. The interest shows how much extra, per term, must be paid on the loan to the lender for the service of providing the loan in the first place. It is how lenders make money. Long-term loans tend to have a lower interest rate, but rates differ according to market conditions and situations.

Amortisation

Amortisation is the process of spreading payments out according to how they will be paid. This divides the entire payment up into different parts based on how often payment will be made and how long they will be made for. Technically, amortisation can apply to any period of time in which periodic payments or deductions will be made, but most people associate amortisation with loans.

Amortising Loans

When a loan is amortised, the amortisation schedule includes not only the original amount of the loan, but also all interest payments. Long-term amortised loans combine both interest payments and principal loan payments into one payment every term, usually every month. This one payment is part interest, part principal, although on many loans, the interest is front-loaded, meaning initial payments are mostly interest and cover very little of the principal. The goal is amortising the loan out through its life while including the rising costs of interest.

Variable Rates

Amortisation schedules can be made accurately as long as there is a fixed interest rate on the loan. If the rate is variable, then there is a chance it could change every term. If the rate changes, the entire amortisation schedule must change in order to recalculate the payments. Variable rate loans are subject to frequent amortisation changes.

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