Amortization of Consumer Debt

Responsible debt management is central to building wealth. Debt amortization describes the process of paying off liabilities, which directly affects your net worth. The amortization of debts reduces interest expenses, while bettering your credit profile for prospective lenders. Debt amortization is particularly important for homeowners and real estate investors that can spend cash to lower their mortgage balances and establish additional home equity.

Debt Principal

Debt principal refers to the balance of money that is owed. As compensation for making loans, banks charge interest expanses as a percentage of loan principal amounts. Interest expenses therefore fall, when loan amortization reduces principal over time.

Debt may be amortized through regular cash flow payments, or credit refinancing. Refinancing begins when borrowers take out new loans at low interest rates. From there, the money from the new loans is used to pay off more expensive existing debt.

Rate Schedules

To save money, borrowers should prioritize their loan payments according to the interest rates of each debt. For example, homeowners should spend extra money to pay down an 18 percent credit card, prior to making additional payments upon a 6 percent rate mortgage.

Be advised that interest charges are calculated at either fixed, or variable rates. Fixed-rate loans feature level interest rates throughout maturity, which means that their amortization schedules are fairly predictable. Variable-rate loans, however, may adjust monthly in accordance to the economic environment. Some variable-rate credit cards and adjustable-rate mortgages begin with a low teaser, or introductory rate. This introductory period could last for one year, before interest rate charges increase significantly. If possible, borrowers should refinance, or spend cash to pay off these loans before the introductory period expires.

Establishing Equity

Long-term mortgage amortization translates into home equity, or financial ownership. Home equity describes the difference between the value of a property and its secured mortgage balance. When selling homes, people can expect to receive real estate profits to approximate their home equity calculations.

Homeowners may also borrow against their home equity. Creditors generally approve home equity loans at relatively low rates, because real estate serves as collateral. In comparison, credit cards feature higher rates, because they are relatively risky loans that are only backed by good faith in debtors to make payments. Due to this relationship, home equity loan proceeds are often used to refinance and amortize existing credit card debt.

Mortgage Interest Deductions

For homeowners, mortgage interest is tax-deductible expense, and not a tax credit. Tax credits immediately lower a person’s tax liability on a dollar-for-dollar basis. Mortgage interest expenses simply reduce a person’s taxable income, before his or her tax liability is calculated. Therefore, purposefully stalling the mortgage amortization process for the sole purpose of tax write-offs does not make economic sense.

Your Credit Report

Credit reports allow American consumers to monitor the success of their debt management techniques. As part of the Fair Credit Reporting Act, borrowers can access one free credit report per year through AnnualCreditReport.com. The website presents instructions to help its users contest any errors on the report.