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Current time:0:00Total duration:4:56

The type of debt that most
of us are most familiar with are mortgages that we might
take out on our homes. What I want to do
in this video is clarify how a mortgage is
different than the type of debt that many corporations
would take on. So if I were to take out a
million dollar mortgage, what happens is is that the bank
figures out a fixed payment that I could pay,
really, every month. And as I pay that
payment-- and that payment will not change over the course
of the term of that mortgage, so maybe it's a
10-year mortgage-- the payment won't change. But as I pay that mortgage,
some part of it is interest, and some part of it is actually
paying down the mortgage. So early on in the
life of the mortgage-- maybe this is the first payment
here-- most of the payment is going to be interest, and
a little bit of the mortgage payment is going
to be principal. And when I say principal, that
little pink part right there, that's actually being
used to pay down the debt on the mortgage. So after this first payment, now
the debt is a little bit less. I'm going to make the same
total mortgage payment. But since the total
debt is now less, I'm taking the same
interest rate-- I'm assuming it's a
fixed interest rate here. But the amount of
interest is going to be less, because I paid off
a little bit of the principal already. So on the next payment,
the amount of interest is going to be a
little bit less. And for that fixed
payment that I'm making, I'm now going to be able
to give more principal. And we keep doing that. I want do that in
the same color. So the next payment after that--
that's not the same color. The next payment after
that, even though it's the exact same
payment, it's going to have less interest, because
I've paid down more of the debt now. So it's going to
have less interest. And it normally doesn't
happen this quickly, but hopefully this
gives you the idea. And it's also going to
have more principal. So that you fast
forward all the way to near the end of the term, so
this is many payments later. This is the end of the 10 years. I think I said this was
a 10-year mortgage loan. On that last payment,
even though every payment was exactly the same
amount-- the mortgage payment was the same dollar
amount every month-- that last payment is going to be
very little interest and mostly principal. And then after
that last payment, you would-- or if I'm that
person taking out the mortgage loan, I would have
paid off the loan. So loan paid off. And I own the house outright
in a traditional fixed rate mortgage. With corporate debt it's
not always like that. In fact, it's not
usually like that. Corporate debt is usually
interest only debt. And there usually might be some
things where the corporation has to pay off certain amounts
of the loans at certain times, but it isn't the model where
you have a fixed payment and you pay off the debt over
a certain amount of time. Most corporate debt-- let's
say a corporation takes a million dollars in
debt, and let's say it's a 10-year loan as well. But the corporation is just
going to pay the interest only. It is going to pay the
interest only the entire time. So whatever this
amount was, roughly, is what the corporation
will pay every month. So they'll pay exactly that
much every time period, maybe every quarter, every
year, whatever it might be. And then you fast forward to
the end of the term of the loan, so they continue paying
that same amount. And at the end of
the term of the loan they have to pay that amount,
plus all of the principal at once. Now, most companies won't have
all of that principal sitting around, whatever it might be. They have to pay all of
the principal at once at the end of the
term of the loan. Well, if they have the cash,
they could pay off the loan. But if they don't have the
cash-- and most corporations would not have the
cash in this situation. That's why they borrowed it
in the first place-- what they would do, is they
would take out a new loan. So they would take
out a new loan for the same amount
of principal, maybe to the same bank,
maybe a different bank. But it might now have
a different interest rate, different loan
terms, whatever. So they'll now
take out a new loan at the end of the
term period, use that to pay the principal
on their old loan. And then they'll
continue paying interest for the term of this new loan. So it's a slightly
different process, and I just wanted to make
sure you understood that. And the other thing, this
isn't all corporate debt. They could be fixed interest
rate, floating interest rate. There's often things
called covenants that the bank will
place on the corporation to make sure that the
corporation isn't doing dangerous things that will make
it less likely that they'll eventually be able
to pay off the debt, or less likely they could
eventually get a loan to pay off the current loan. So there are controls
that the bank has to make sure
that the company is good for this near
the end of the term. But as you can see, it's a
fundamentally different process than most mortgage loans.