As far as borrowers go, Navlur is a rare breed. Borrowers typically have horror stories to tell about loan tenures that have been extended till retirement, credit cards charging astronomical amounts and harassment by lenders due to missed EMIs. The people who have taken multiple loans are the worst hit. Even if they miss one EMI, it casts a slur on their credit report and makes it more difficult for them to take loans in future. If you also find it difficult to repay your loans, you may need to tweak your approach. In the pages that follow, we outline some strategies that can help you manage your debt situation without stressing your wallet.
Repay high interest loans first
As a first step, you need to prioritise the repayment of your loans. Make a list of all outstanding loans and then identify the ones that need to be tackled first. Ideally, start by repaying the costliest loan. Ravi Raj, Cofounder and Director, CreditVidya, says,“First attack the loans with the highest interest rate, such as credit cards and personal loans. This will reduce your interest burden going forward.” Pay the maximum amount you can afford against the high-cost loan without jeopardising the repayment of the other loans. Once you have cleared the costly debt, move to the next one. This technique is the ‘debt avalanche’ (see graphic).
Some might be tempted to repay the smallest loan first. The idea is to eliminate the smallest and then move to the next smallest loan. This ‘debt snowball’ strategy helps ease some pressure because the number of loans comes down, but it won’t actually pare down your aggregate debt faster. In fact, it will keep you in debt longer and will cost you more compared with the avalanche approach. While prioritising your debt repayments, also consider the tax benefits on some loans.
Some loans may seem costly, but the tax benefits they offer bring down the effective cost for the borrower. For instance, the interest paid on an education loan is fully tax deductible. If you factor in the tax benefits in the 30% tax slab, an education loan that charges 12% effectively costs 8.5%. Similarly, tax benefits bring down the actual cost of a home loan. There’s no pressing need to end such tax advantageous loans earlier.
Increase repayments with rise in income
One simple way to repay your loans faster is to bump up the EMI with every rise in your income. Assuming that a borrower gets an 8% raise, he can easily increase his EMIs by 5%. The EMI for a 20-year home loan of Rs 20 lakh at 11% rate of interest comes to Rs 20,644. The borrower should increase it by around Rs 1,000 every year. Don’t underestimate the impact of this modest increase. Even a 5% increase in EMI ends the 20-year loan in just 12 years (see table). It helps the borrower save almost Rs 12 lakh in interest. “Whenever there is additional money flowing in, priority should be given to the prepayment of loans,” says Raj. If you have multiple loans running at the same time, make sure that you direct the additional payments towards the costlier loans, as discussed earlier.
Received a fat bonus? Do not splurge on the lastest smart phone or newest plasma TV. Use the money to pay down your debt aggressively. Windfall gains, such as income tax refunds, maturity proceeds from life insurance policies and bonds, should be used to pay costly loans like credit card debt or personal loans. “Use a part of any bonus or proceeds from asset sales to bring down your costlier debt as much as possible,” says Suresh Sadagopan, Founder, Ladder 7 Financial Services. However, remember that the lender may levy a prepayment penalty of up to 2% of the outstanding loan amount. While the RBI does not allow banks to levy a prepayment penalty on housing loans with floating rate interest, many banks do so for fixed rate home loans. Lending institutions normally do not charge any prepayment penalty if the amount paid does not exceed 25% of the outstanding loan at the beginning of the year. If you are likely to incur a penalty, compare the cost with the interest saved if you prepay the loan.
Convert credit card dues to EMIs
Credit cards are convenient and give you interes-free credit for up to 50 days. However, they can also burn a hole in your wallet if you are a reckless spender. If you regularly roll over the credit card dues, you shell out 3-3.6% interest on the outstanding balance. In a year, this adds up to a hefty 36-44%. If you have run up a huge credit card bill and are unable to pay it at one go, ask the credit card company to convert your dues into EMIs. Most companies are willing to let customers pay down large balances in 6-12 EMIs.
If the sum is big, they may even extend it to 24 months. “Converting your credit card bill into an EMI option will give you the much-needed breathing space,” says Rustagi. However, if you miss even a single EMI, the rate will increase to the regular rate of interest your credit card charges. You can also take a personal loan. These are costly and charge up to 18-24%, but they will still be cheaper than the 36-44% you pay on the credit card rollover.
Use existing investments to repay debt
If your debt situation becomes bad, you can use your existing investments to make it better. You can borrow against your life insurance policy or from the PPF to pay off your loans. The PPF allows the investor to take a loan against the balance from the third financial year of investment, and the same is to be repaid within three years. The maximum loan one can take is up to 25% of the balance at the end of the previous year. The rate of interest charged on the loan is 2% more than the prevailing PPF interest rate. Right now, it will work out to 10.5%, which is much lower than that you would pay on your other loans. A higher interest is charged if the loan is not repaid within 36 months.
Your gold holdings can also be put to productive use should the need arise. “If you have substantial gold jewellery, consider borrowing against the same to pay off any high cost credit card debt,” suggests Raj.
Some investments can also be liquidated completely. “If you have fixed deposits fetching a 9% rate of interest, but are also servicing a personal loan at 16%, it makes sense to liquidate the fixed deposit to prepay the loan,” urges Sadagopan. However, one should withdraw from one’s PPF or Provident Fund accounts to pay off debts only in extreme situations. These are longterm investments which should ideally be kept untouched to ensure that compounding works its magic.Consolidate or refinance
It can be quite challenging to keep track of EMIs and interest rate changes if you have multiple loans. Missing an EMI means penal interest and a bad credit score. Consider consolidating all your debt, which involves combining several loans into one single loan. The idea is that you avail of a loan with a much lower interest rate than that being paid on existing loans. Apart from the lower rate, having a single loan will offer greater ease in repayment. For instance, if you have a huge outstanding bill across multiple credit cards, you can approach a lender for a personal loan, where the entire outstanding amount can be repaid at a much lower rate than your credit card. Brijesh Parnami, CEO, Destimoney Advisors, says borrowers must replace costly, unsecured loans with secured loans that are cheaper. “Those with freehold property can consider consolidating their personal or vehicle loans by taking a loan against the property,” he advises. You can choose a tenure that is comfortable and an EMI that is affordable.
Interest rates are likely to change soon. Keep track of what is the going rate in the home loan market. If you can get a better rate, have your loan refinanced. This will involve a one-time cost, which is typically around 1-2% of the outstanding loan, with a cap ranging between `25,000 and `50,000 depending on the bank. The gain from this refinancing should be higher compared to the charges you pay. Raj advises against refinancing if the loan is more than seven years old. “If you refinance after seven years, you may end up shelling out more than the gain you make.” If your home loan is relatively new and on a fixed rate of interest, this is a good time to look at refinancing. As a rule, if the prevailing rate of interest payable on your home loan is 1% more than the interest rate on offer in the market, you should consider refinancing your home loan. Beware of loan agents asking you to shift your floating rate loan to a fixed rate one at this point. Axis Bank, for instance, has recently launched a 20-year fixed rate home loan for affordable housing at 10.4%. With rates expected to climb down, you may lose out if you switch to a fixed rate loan at this stage.
Make lifestyle changes
It is often the little things that go a long way in keeping your finances in fine fettle. While so far we have discussed different ways in which you could reduce your loan burden, you may also need to make some lifestyle adjustments to accommodate your loan repayments and ensure you have enough money to pay higher EMIs. A lifestyle change is needed until all debts are repaid. This means cutting down on luxuries and unwanted spending. Go slow on movie shows, dining out and weekend getaways. Keep the credit card locked up when you go to the mall and try to make purchases with cash. This will automatically curb your propensity to spend. “Put everything else on the backburner. Your planned vacation or home refurnishing can wait. Focus on reducing your debt first,” insists Sadagopan.
In extreme cases, you could also get your credit card company to lower your spending limit. Most importantly, cut down on taking fresh loans unless these are taken to prepay existing, costlier loans. Automatically debit your repayment dues to your bank account. In this way, you eliminate the possibility of missing the payment by mistake. Remember, paying after the due date attracts late fee and impacts your credit score negatively.
Lastly, do not feel shy to cry out for help. If you are unable to figure out a way out of your debt hole, approach a debt counselling centre, such as ICICI Bank’s Disha and Bank of India’s Abhay, which offer free advice, or institutions like Credit Vidya and Credit Sudhaar, which charge a fee for their services. These are actively engaged in helping borrowers facing problems with their loan repayment by offering credible advice.
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Hridaynath Patra2037 days ago
People buying home or vehicle on loan are always face the problem of repaying it. In most of the cases, they have to extend the loan burden till the end of their service life. This article would definitely help those people to plan their repayment process.