Sometimes Loans can make Life miserable
Suppose you like palada paayasam (porridge) a lot. What will happen if you have 10 cups at one go? Indigestion! Same is the case with loans. Loan are not bad. But you should know how much loan can you afford. Otherwise you will fall into debt trap.
What is debt trap? It is a situation when one is not able to make the loan repayments from his or her income and hence has to borrow to make loan payments, month after month. Raju, a private sector employee has a salary of Rs.50000 per month. He has recently taken a home loan of Rs.20 lacs for a term of 7 years. The EMI is Rs.31673 at an interest rate of 8.5%p.a. His monthly expenses are about Rs.10000. He has an auto loan EMI of Rs.7752. He bided for a chit which has an instalment of Rs.3000 per month. He has a shortage of Rs.2425 every month and has to borrow every month to fulfil his commitments. This shows that even a person who is not spent thrift can fall into a debt trap. If he has opted for a longer loan term he could have reduced the EMI and avoided the shortage. So when it comes to large loans it is better to opt for a longer repayment term. This will help to avoid situation of borrowing to make loan repayments.
The interest rates can make a big difference in your borrowing ability as well as repayment period. Suppose you have Rs.1 lac as credit card balance. The interest will be about 3.5% per month and after including service tax it will be about 4% per month. This means that the annual interest rate will be about 48%! If you are paying just the minimum requirement of 5% of the outstanding amount every month, in the next 12 months you will paying interest of about Rs.46000. Similar is the case of personal loans and consumer loans. Such loans are usually not taken to acquire assets. These are often taken to pay for your impulse purchases.
As life progresses, you will be buying things like car, mobile phone, TV, fridge, washing machine and other house hold articles again and again. You should take a decision to use these things till the time the cost of maintenance is not equal to buying a new one. Then note down in a diary, when you will have to buy each of this item next time. Accordingly set aside an amount every month in a bank account so that you can use it to buy these on the dates you have planned. This will help you to avoid short term consumer loans and credit card debts. It will also avoid impulse purchases.
Set aside an amount equal to your 3 months’ expenses and loan payments in a bank account as an emergency fund. In case of any unforeseen circumstances this will help you avoid borrowing. You can replace the amount taken over next 12 months.
Life is unpredictable. Certain untoward life incidences can push you into debt trap. Ensure that you have medical insurance for yourself and family so that you will not have to borrow to pay or jeopardise your savings plans. Ensuring ample life insurance to cover your loans will protect your family from falling into debt trap in your absence.
How much loan can you afford? Ideally your total loan repayments including the bided chit payments should not exceed 35 to 40% of your income. If you structure your loans and maintain a discipline in spending, you will be able to contain your loan payments within this limit.
Preparing a financial plan early in life will help you understand the financial needs over your life time. This helps you to understand how much you can spend and how much you should save to meet your life goals. It will help you to control the urge for instant gratification ignited by luring advertisements. Once you have the big picture of your life you will take more rational decisions with respect to spending and taking loans.
PrognoAdvisor.com’s Online Comprehensive Financial Planning can help you restructure your loans and remove your worries about loans and thereby start saving. It also helps you with advice on controlling expenses and optimising insurance.
Apart from the above it will help you plan for your kid’s higher education and other goals like Retirement, children’s marriage, buying a home, buying car, going for vacation etc.
PrognoAdvisor.com is a SEBI Registered Investment Adviser Company and does not sell any products. Its unique advisory process which combine cash flow planning and goal planning ensures that the plan is practical.