An escrow payment is an amount deposited with another party and it is to be released only for its specified purpose.  The following is one example of an escrow payment.

A borrower and lender arrange for the borrower’s monthly mortgage payment to include an amount equal to one-twelfth of the property’s annual real estate tax. Assuming the annual tax is $6,000 the monthly mortgage payment will include an escrow payment of $500. When the lender receives these monthly escrow payments of $500 each, the lender must hold them in escrow, or hold the funds in an escrow account. When the annual real estate taxes come due, the lender pays the real estate taxes by using the money in the borrower’s escrow account.

A lump sum payment is often associated with a single amount paid to acquire a group of items. For instance, a corporation might pay $50,000 for the inventory and equipment of a small manufacturer that is going out of business. The transaction did not specify any further details. The $50,000 is a lump sum payment.

Sometimes the term lump sum payment merely indicates a single payment. For example, the maturity value of a bond might be referred to as a lump sum payment in order to distinguish it from the series of semi-annual interest payments.

To amortize a loan usually means establishing a series of equal monthly payments that will provide the lender with 1) interest based on each month’s unpaid principal balance, and 2) principal repayments that will cause the unpaid principal balance to be zero at the end of the loan. While the amount of each monthly payment is identical, the interest component of each payment will be decreasing and the principal component of each payment will be increasing during the life of the loan.

To illustrate, let’s assume a lender proposes to amortize a $60,000 loan at 4% annual interest over a 3-year period. This will require 36 monthly payments of $1,771.44 each. The first payment will consist of an interest payment of $200.00 ($60,000 X 4% X 1/12) plus a principal payment of $1,571.44 ($1,771.44 – $200.00). After the first payment is made, the principal balance will be $58,428.56 ($60,000.00 – $1,571.44). The second monthly payment of $1,771.44 will consist of interest of $194.76 ($58,428.56 X 4% X 1/12) plus a principal payment of $1,576.68 ($1,771.44 – $194.76). After the second payment is made, the remaining (or unpaid) principal balance will be $56,851.88.

The 36th and final monthly payment of $1,771.44 will consist of interest of $5.89 (the principal balance after the 35th payment, which will be $1,765.55, times 4% X 1/12) plus a principal payment of $1,765.55. After the 36th payment the loan balance will be zero. In other words, the loan will have been amortized over its 3-year term.

A listing of each month’s interest and principal payments (and the remaining, unpaid principal balance after each payment) is referred to as an amortization schedule.

When loan costs are significant, they must be amortized because of the matching principle. In other words, all of the costs of a loan must be matched to the accounting periods when the loan is outstanding.

To clarify this, let’s assume that a company incurs legal, accounting, and registration fees of $120,000 during February in order to obtain a $4 million loan at an annual interest rate of 9%. The loan will begin on March 1 and the entire $4 million of principal will be due five years later. The company’s cost of the borrowed money will be $360,000 ($4 million X 9%) of interest each year for five years plus the one-time loan costs of $120,000.

It would be misleading to report the entire $120,000 of loan costs as an expense of one month. Hence, the matching principle requires that each month during the life of the loan the company should report $2,000 ($120,000 divided by 60 months) of interest expense for the loan costs in addition to the interest expense of $30,000 per month ($4 million X 9% per year = $360,000 per year divided by 12 months per year). The combination of the amortization of the loan cost plus the interest expense will mean a total monthly interest expense of $32,000 for 60 months beginning on March 1.

I would define a toxic asset as an investment whose value has dropped significantly and there is no market in which to sell the asset.

To illustrate, let’s assume that at the peak of the real estate market you lent $150,000 to someone who was purchasing a house for $170,000. In other words, you made a $150,000 investment and recorded it as the asset Mortgage Loan Receivable. The house is the collateral for the loan receivable. Within one year, the local housing market drops by 30% and the borrower loses her job. She stops making the loan payments and at that point your Mortgage Loan Receivable account shows a balance of $147,000. This scenario is widespread in your community and houses are not selling.

I would consider your Mortgage Loan Receivable to be a toxic asset. There are few investors willing to purchase a loan without payments being made by the borrower, the value of the collateral has dropped to less than $120,000 ($170,000 minus the 30% average drop in value), and a lot of houses are for sale with virtually no buyers.