In terms of personal finance and business liabilities, amortization refers to the process of paying off liabilities, which directly affects net worth calculations. Over time, debt amortization reduces interest expenses, while also improving applicant credit profiles for prospective lenders. Debt amortization is of particular interest for homeowners and real estate investors who commit to making regular cash payments to lower their mortgage balances and establish additional home equity.
Be advised that stock market analysts may present a different interpretation of amortization. Amortization may best be described as the depreciation of intangible assets. For example, Apple may purchase $10 million worth of smartphone patents, which carry an estimated viable life span of five years. Apple may then take $2 million worth of annual amortization charges related to these patents.
Debt principal refers to the balance of money that is owed. As compensation for making loans, banks charge interest expenses as a percentage of loan principal amounts. Again, interest expenses will 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. Debt refinancing is an important tool used to improve cash flow.
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. These seemingly minor decisions and transactions may add up to tens of thousands of dollars in savings over the years.
Be advised that interest charges are calculated at either fixed, or variable rates. Fixed-rate loans charge level interest rates throughout maturity. As such, fixed-rate loans are associated with fairly regular amortization schedules. Variable-rate loans, however, may adjust monthly in relation to the economic environment. Many variable-rate credit card and adjustable-rate mortgage loans do 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.
Long-term mortgage principal 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.
Corporate balance sheets categorize information according to assets, liabilities, and shareholder equity. Shareholder equity is what remains, after subtracting liabilities away from assets. Intangible assets, intellectual property, and patents, of course, are a part of corporate assets. These assets will depreciate, or amortize, over time. Amortization costs will be added back to net income to calculate cash flow from operations.
Tax Write Offs
For homeowners, mortgage interest is a 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 the filer’s taxable income, before his or her tax liability is calculated. Small businesses and corporations may also deduct interest expenses out of income. Be advised that purposefully stalling the debt and mortgage amortization process for the sole purpose of tax write-offs makes little to no economic sense.
Free Credit Reports
Credit reports allow American consumers to monitor debt amortization progress. 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 American consumers contest and correct any errors within the report.