Changing the way you spend and save can help tackle existing debt and keep you sorted in future too
Having good debt like a home loan isn’t an issue but funding a lifestyle you can’t afford can land you in trouble
The tragic end of V.G. Siddhartha, founder of coffee chain Cafe Coffee Day (CCD), is a reminder of how piling debt can drive one to the edge. A day before Siddhartha was found dead on the banks of Netravati river in Karnataka on 31 July, a note believed to have been written by him surfaced, saying he was under a mountain of debt, estimated later to be over ₹11,000 crore. While that was a staggering figure, smaller amounts of debt can be equally burdensome if you are unable to service it. Just last month, unable to clear a debt of ₹8 lakh, a man jumped off a Delhi building with his daughter in his arms; minutes later, his wife jumped to her death too. Such cases are not a recent phenomenon. In a shocking case that came to light in 2007, a Mumbai-based resident Prakash Sarvankar, 38, committed suicide, accusing a recovery agent for his death. He had reportedly taken a ₹50,000 personal loan from a bank and was allegedly being harassed by the bank’s recovery agent.
Falling into a debt trap knowingly or unknowingly is of course a problem but not being able to handle the situation properly is a bigger one. There are ways to manage debt, especially personal debt, and eventually even coming out of it. We tell you how to go about it, but first a reality check.
The first step is to know where you really stand financially. If you are among those who live pay cheque to pay cheque, borrow from friends or family to get through the last few days of the month, swipe credit cards to meet wants, and take loans to buying possessions and experiences, you may be heading towards a debt trap or may be already there (take our quiz, ‘Is your Financial Life in the Red’, to find out your status). With easy availability of credit these days, sometimes you may not even realize when you start living on the edge, financially.
D. Muthukrishnan, a Chennai-based certified financial planner, said, “If more than 30% of your monthly income goes towards servicing your EMIs on various loans, you are close to being in a debt trap." If that number is more than half, you are definitely in a debt trap. While some planners might think 30% is a conservative number, and 40% is more realistic, 50% is definitely too much even if it’s just going into servicing the equated monthly instalments (EMIs) for home loans, which is typically considered good debt.
Like home loans, not all debt is bad. Mukesh Dedhia, a Mumbai-based certified financial planner, said, “Debt is really categorized into two kinds. The good and the bad debt. A debt taken to fund an appreciating asset, like a home loan, is an example of good debt. After all, in the years to come, the value of your home can only increase. A debt taken to fund a depreciating asset is bad debt." For instance, buying an expensive smartphone that you can’t really afford.
Making the mental shift
If you realize you are indeed in trouble, don’t despair. There’s a way around everything. What you need is the determination to get rid of the debts, and a large dose of patience.
Before you even start attacking your debt, you need to change how you view saving and expenditure. Parag Paranjape, a Nagpur-based certified financial planner and founder director of Think Consultants, a financial planning firm, said, “Cut down your expenses. It’s not going to be easy. It’s going to be mental shift from the equation ‘income - expenses = savings’ to ‘income - savings = expenses’. In other words, decide how much you want to save in advance, and then plan your expenses accordingly." Be disciplined to reduce expenditure, save more and make payments towards repaying debt, he added.
All financial planners we spoke to agreed that the mentality that got you into the problem won’t help you get out of it. “There are two reasons why people get into bad debt. First they don’t understand money concepts, and second it’s a behavioural issue," said Dedhia.
For those who are ready to make the mental shift from spending first and saving later to saving first and spending later, we have a strategy.
Layer your debt
Start with gathering all loan-related documents at one place, and compute how much you owe. But while doing so, be mindful of the due dates of all your EMIs, and factor in the recurring dues on your utility bills.
Then sort your debt, keeping the highest interest rate loan on top and the lowest interest rate debt at the bottom.
“Start aggressively attacking the most expensive debt (highest interest rate), by paying as much as possible towards it," said Muthukrishnan. Paranjape agreed, “Put the rest in a descending order of cost."
Pay at least the minimum amount due on all remaining debts, but pay as much as possible (over and above the minimum due) towards the most expensive debt. Once you get rid of the highest rate debt, zero in on the debt with the next highest interest rate, and so on. “You can even consider refinancing your debt. That way you will be able to save money and pay the saved amount towards your other loans," said Paranjape.
“Credit card should be the first to focus on, it’s after all the most expensive form of debt," said Muthukrishnan. Credit card debt is usually in the range of 36-45% per annum. This is followed by personal loan, car loan and, finally, the home loan. “As a one-time exercise, you might consider getting a lower interest loan to pay off the high interest rate credit card debt," said Paranjape. The lower interest rate loan could be in the form of a personal loan, or loan against an asset or even a credit card balance transfer. Balance transfer on credit cards work well at lower interest of around 1.5% per month. Some financial apps like LoanTap offer credit card takeover loans, which are like personal loans that cover the dues from multiple credit cards. “Instead of being stuck with high interest credit card debt, it makes sense to swap the high interest rate credit card debt for a fixed rate personal loan of shorter duration," said Satyam Kumar, chief executive officer and co-founder, LoanTap Financial Technologies Pvt. Ltd.
Settling the high interest rate debt on all your cards can be helpful as servicing a single EMI at a cheaper interest rate may be a lot simpler. Credit card takeover loans are like personal loans and are available at around 1.5% monthly interest versus 3-4% monthly interest applicable on outstanding credit card payments. However, Paranjape has a word of caution. “After taking another loan to pay off credit cards, you should not start reusing the cards again. Else, you will defeat the purpose and dig yourself into a deeper debt hole," he said.
Finally, it’s not just about getting out of debt but staying out of it in the future too. All planners we spoke to said that having good debt like a home loan isn’t an issue. But funding a lifestyle you can’t afford can land you in trouble. “People get carried away by advertisements, and desire to be like others. They don’t realize that freedom is the most important form of happiness. What’s the point of having possessions and experiences when you don’t have freedom? A borrower will always be a slave to a lender," said Muthukrishnan.
However, it’s not always the desire to possess things, rather life circumstances like a struggling business, or job loss or health reasons which can lead you into debt. In such situations, it’s best to seek professional help from debt counselling agencies such as Abhay Credit Counselling Agency and ICICI Bank’s Disha Credit Counselling Agency. Else, approach a financial planner or a behavioural psychologist. So don’t let mounting debt break you, work around it to get rid of it.