It is so easy to get into a debt trap and so difficult to get out of one. In a competitive world, bankers and financiers are falling over each other to lend you money. That does not mean that you actually take money from them. You need to do your own affordability analysis before taking loans. Here are 7 key points to keep in mind to ensure that your loan burden remains in check..
Your EMIs put together should not be more than 40% of your income
Is there an affordability benchmark? It can differ from person to person but the bottom line is that all your EMIs put together should not exceed 40% of your income. When we say all EMIs, we actually mean all EMIs. Your EMIs towards your home loan, personal loan, car loan and your credit card payable should not exceed 40-50% of your total income each month. Also check the quality of your loans and check whether they are contributing to creating assets or not. If the EMIs including your home loan is 50% it is understandable. But if the EMIs towards your personal loans and car loans are coming to 40% then that is not a sustainable scenario. Apart from the percentage of income, also check the quality of assets that are being financed by these EMIs.
Avoid high cost loans as they can spiral your liabilities
Apart from the quantum of loans, the cost of loans also matter. Typically, personal loans and credit cards are examples of high cost borrowings. The EMI on these should be less than 10% of your income. Also avoid the temptation of rolling over your credit card dues by just paying 5% each month. That may sound amazingly convenient but it going to take a huge toll on your finances. Personal loans cost around 21% per annum while credit cards cost around 35% per annum. When you get low cost loans make it a priority to first close your high cost loans.
Prefer shorter tenures to longer tenures
A 25-year home loan or a 7-year car loan or even a 5-year personal may look easy on the pocket, but there is a huge hidden cost. Considering these statistics! If you borrow at around 10% for tenure of 10 years then your interest cost will be around 57% of your principal through the tenure of the loan. Instead, if you go for a 25-year loan then the interest cost will be 167% of your principal amount. The longer the tenure of the loan, the greater you pay as interest component. So longer tenures do not come cheap! Given a choice and if affordability permits, then always prefer loans of shorter duration over longer term loans.
Keep an eye on your credit rating score regularly
What is a credit score? CIBIL maintains individual database of credit history of individuals in India. You can check your CIBIL score by paying a small fee through your bank. The CIBIL score is based on your total loans plus your servicing regularity plus instances of cheque bounces in your bank account. A credit rating score of 750 is considered to be a good score to avail loans and be seen as credit worthy. Keep checking your credit scores at regular intervals. Your credit score could deteriorate either due to excess borrowings or due to a bad repayment track record. Use this opportunity to cut down on your loans and improve your credit score.
Borrowing to invest in equities is a strict “No”
When you take a personal loan, it is quite normal to ask for the purpose of the loan. That is because the RBI strictly prohibits people to borrow from banks to invest in the stock markets. But that is something a lot of borrowers do. They take personal loans for the sake of family expenditure and use the money for investing in the capital markets. That is a situation that is best avoided. Borrowing at 15% and investing at 30% is easier said than done. Remember, stock markets can be irrational much longer than you can be solvent. Your stock returns will fluctuate but your EMIs on the loan will have to be serviced at regular intervals. It could create a mismatch and is best avoided.
Ensure that your loans are backed by insurance
We all know of asset insurance, but there is also something called liability insurance. When you take on a personal loan or a home loan, you need to attach a term plan to the extent of your principal outstanding. Else, in the event of some unfortunate event befalling you, your family will be left holding the burden of the loan. In case of a home loan, they may have to forfeit the house, which is not a very comfortable situation to have. Under these circumstances, it is best to have an insurance attached to the loan, at least to the extent of the outstanding amount.
Shop around and bargain hard with the banks
Yes you can bargain for loans too! How to go about it? Firstly, there are online websites that allow you to compare loan options in terms of leverage and cost. Once you select the best option, you can bargain with the lender on the administrative fees, upfront costs and the rate of interest. If your credit track record is good, then you stand a much better chance of getting better rates. This is a buyer’s market and you must bargain hard to get the best deal.
There is nothing as wrong in borrowing as Polonius made it out to be. But in the interest of prudence it is always better to keep your borrowings in check!
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