Consumers and businesses rely upon debt to purchase equipment and finance everyday items. Of course, debt financing adds to the costs of these transactions because of interest expenses. Efficient debt extinguishment is critical to build wealth.
Identification
Debt extinguishment, or retirement, describes the process of paying off loan balances. Corporations extinguish bonds and commercial paper. Individuals extinguish credit cards, mortgages and student loans. Retire debt with cash reserves, or by refinancing into new loans.
Features
Proper debt extinguishment is reliant upon interest rates. High interest rate debt should be paid off more aggressively to save interest expenses immediately. Be advised that adjustable rate loans generally offer low initial rates before adjusting higher. If possible, retire adjustable rate debt before rate increases take hold.
Considerations
Pay off low interest rate debt over the long term to use leverage for growth. Leverage works by purchasing investments that earn higher rates of return than interest expenses associated with the underlying debt financing. Most homeowners leverage mortgages to buy real estate.
Benefits
Debt extinguishment reduces current interest expense and builds wealth. Further, banks review your credit history while approving loans. Banks offer low interest rate loans to customers demonstrating strong debt management.
Risks
The failure to eliminate debt may cause financial distress and bankruptcy.
