Debt extinguishment is the elimination of a debt by paying the full balance owed or by replacing it with another debt instrument. While this term is more commonly used in describing the process through which businesses eliminate debt, it may also refer to personal finances.
There are basically two ways to extinguish your debts: You can pay a loan off or refinance it with a new one. Paying off debts is obviously the best way to eliminate them. However, getting lower interest rates or reducing monthly payments by refinancing to a better loan definitely has benefits. You can improve your monthly budget situation and minimize the total amount you pay in interest over the life of the loan.
Types of Debt
Home loans and auto loans are two major, long-term loans that many adults carry at any given point. Typical homeowners factor these loan payments into their monthly budget planning. Store financing on appliances, personal loans and credit cards are other types of consumer debt that usually carry shorter terms. Extinguishing all debt as soon as possible is obviously the idea, but some people try to minimize reliance on short-term debt and stick to the basics. Extinguishing a home loan in some cases may be to your disadvantage since you usually get tax breaks on home loan interest and property taxes.
In looking over your debt situation, it is important to develop a sound strategy on the order of your debt pay-off. You are probably in for the long haul on a home loan, but paying a few dollars extra each month can help you lower your typical repayment period of 15 to 30 years. Car loans are usually for 36 to 72 months, but you can also pay extra on them. Generally, though, personal loans and credit cards have the highest interest rates for consumers. Meeting minimum obligations on other loans and paying aggressively on credit cards in order of descending interest rate is normally your best move. As you extinguish one debt, you free funds to put toward the next.
Avoiding debt extinguishment makes sense in some situations. Some home loans have prepayment penalties of several thousand dollars. This may restrict your ability to sell your home or refinance. An alternative to paying extra principal on your home is an investment with reasonable expectation of returns that exceed the monthly interest on the loan.
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