Evaluate loans based on the interest rates and tax efficiencies they offer
I am 32 and have two credit cards with total debt worth Rs6 lakh. I am unable to pay it off despite my best efforts. I earn around Rs 1.3 lakh a month and have expenses of Rs65,000. I’m the sole earning member. I also want to save towards retirement and my daughter’s (2-years-old) education. I don’t have much investments. Kindly help.
In today’s time, the lure of easy money in the form of plastic money or loans is difficult to ignore. It is just everywhere around us, with retailers trying to entice you with words like: ‘pay by credit card’ and ‘pay in easy to pay instalments’.
These enticements tend to affect those spenders most who avail a credit line without first thinking, whether they really need to buy the particular product or asset.
Sometimes the urge to buy or spend is so strong, that you could skip the basics: asking the simple question, “How will I repay .”
But we ignore all this thinking we can either pay next month or can pay easily via equated monthly instalments (EMIs), without realising that we have gone overboard and much beyond our means.
The cost of servicing the payments does not even bother us. And then, when it gets tough to repay, we use the apparently easy route of paying the ‘minimum payment’ without realising that the EMI and the balance carried forward are subject to penal interest rates.
So you end up paying the interest on EMIs. The cost of servicing a personal loan is typically 13-15% per annum and the delayed payments on credit cards mean an interest rate of 3-3.5% per month.
While you need to think before taking up a loan, it is not that all loans are bad. There are good loans and there are bad loans. Good loans are those that offer you tax efficiency and are taken for buying appreciating assets like real estate. It does not mean that you should go on a real estate buying spree. You cannot ignore the basic principle of financial planning, cash flow management, which helps in deciding the quantum of loan.
So, these loans can be considered as good loans till the time you don’t end up over-leveraging.
Also remember that construction-linked properties don’t get the tax benefit till they are in possession and are occupied. Another way to judge whether a loan is good or bad is the rate of interest. If the rate of borrowing is lower than the interest earned on your assets, it can be considered a good loan.
So, if a car company wants to promote a specific model and bears the complete or partial interest cost, then it could be a good option to buy the car on loan, but only if your own investments are yielding a higher rate of interest.
Any loan which does not meet these criteria, can be classified as a bad loan.
In your case, it seems most of your loans are bad loans.
Prima facie, it does not look like you have invested in appreciating assets and there is no tax efficiency either.
You are also paying a very high interest rates—both in the form of EMIs as well as due to late payment.
The saving grace is you are earning well and going forward you should avoid these debt traps. But what are the steps to be taken to get out of this current trap?
Check your current interest rates and convert your outstanding debt to a loan and a fixed EMI, if not done so already. Also check what interest rates are available to you on other loans. Opt for the loan that offers you the lowest interest. The tenure of the loan should be fixed, subject to your payment capacity. If you can pay Rs65,000 per month, then plan accordingly.
If not, plan the EMI that you can pay without any default. In case you have any other source of income coming in the near future, say bonus, then opt for a loan that allows you to pay a bullet payment without prepayment charges.
With this you should be able to pay the loan within a year’s time. And once you have paid all your outstanding debt, start building a corpus with your monthly surplus for your daughter’s education and your retirement.
Surya Bhatia is managing director and principal officer, Asset Managers.
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