You have probably heard about amortization more than once. However, it is likely that, although it is a term that economists and specialists often use, you may have difficulty understanding it. Because... do you know what amortization is, what types there are and how it is calculated?
If you want to master this concept as best as possible and get the most out of it in terms of your household finances, then take a look at what we have prepared for you to understand it.
What is an amortization
Let's start at the beginning. And that is to understand what we mean when we say the term amortization. In reality, it is a loss we suffer when we have an asset.
To give you an idea, imagine that you have just bought the most special television in the entire world. It cost you money and now you just want to enjoy it. However, as time goes by, what you paid for that television is not what you could get for it. As time goes by, the money you paid for the television will not be the same.
Well, that's what's called amortization.
In other words, it is about how assets (products, services, objects, etc.) stop losing the value for which you acquired them. And there comes a point where they are no longer worth anything.
Let's give you another example that's easy to understand. As you know, there are several Playstations, right? When the Playstation 3 came out, it made the Playstation 2 obsolete and stores bought them second-hand for a price that wasn't what you had paid. In the case of Playstation 4 and 5, which are the current ones, selling them now means that you don't get the same amount you paid for them.
That would be, in a way, amortization, because it is not worth the same as when you acquired it.
Types of amortization
Now that you have a better understanding of what amortization is, the next step is to find out what types of amortization exist. There are several, but the most commonly used and common ones are the following:
Accumulated amortization
It is called the depreciation of assets over a given period (several years). In other words, what you are trying to do is find out what amortization a product or asset would have after a certain number of years.
Let's use an example to help you understand. Imagine that you buy a television and it costs 1000 euros. In four years it won't be worth that much, but you'll have to subtract the annual depreciation that it has been losing year after year.
Therefore, the formula for this amortization is:
Accumulated amortization = Annual amortization x Years since purchase.
That will tell you how much depreciation the product itself has lost. And if you subtract that from what you paid for the product, you'll see what your product would be worth at that point in time.
Technical or economic amortization
This type is used to prepare you for the replacement of that asset. And that is It consists of saving the same amount that is amortized year after year by the asset, so that when time passes and you have to buy another asset to replace the one you have, you already have that money saved.
Amortization of an investment
This concept is not widely used in home economics, but understanding it can be very useful. It focuses on know when your purchase is profitable. To do this, you need to compare the products you can choose and see if the price difference between one and the other would be paid off in more or less time. The goal is to know when you will do it so you can start seeing benefits.
To give you an example, imagine you want to invest in a coffee shop and you have to put in 30.000 euros. Here, you have to know when you are going to recover the money you have invested in order to start seeing profits. If that payback is not going to happen in 20 years, then it may not be profitable. But if it happens in one or two years, the investment could be a good option.
Amortization of a debt
Refers to outstanding payments that you have left to settle the debt. That is, if you are paying for a course in installments, your debt amortization would be the payments you have left to pay off.
Amortization of a mortgage
Similar to the above, we would be talking about the mortgage, instead of the debt. However, you should know that sometimes, Amortization is also called paying off the remaining amount of your mortgage before the end of the term.
Amortization of a loan
It would be the same as the above, that is, what you have left to pay on the loan as time goes by.
How to calculate amortization
Now that you know what amortization is and how many types there are, let's move on to how it is calculated. The truth is that it is quite easy because it is governed by a formula. Which one? I'll tell you:
Annual amortization = Purchase value / Estimated useful life.
Let me give you an example to help you understand. Imagine that you have bought the Playstation 5. We know that it will be on the market for about 6 years, because there are already rumours about the next console. So the estimated useful life is 6 years. Now, the purchase price is what you have paid for that console. Let's say 600 euros.
Well, following the formula, you would have to divide those 600 euros by 6 years, so that you get 100 euros. That is how much your console “depreciates” every year.
You can apply the same thing to many other things, whether it be appliances, training, services, or any other asset.
Is it now clearer to you what amortization is, how many types there are and how it is calculated? Believe it or not, this can be very useful for your household finances because it will help you make better decisions regarding the purchases you make and whether they really suit you or not. Do you still have any questions? Feel free to contact us.