Maintaining a fine balance for your borrowings is the key to achieving financial security. Hereâ€™s how you can make friends with â€˜debtâ€™ and avoid the pitfalls of borrowing.
Debt is no longer a dirty four letter word. It is the privilege of spending money you donâ€™t have. Today, every financial institution is pushing consumer loans, home loans, car loans and credit cards aggressively. With the variety of loan products on offer, you can get easily swayed into taking on a loan. Borrowing has its own advantages, provided you know how to manage debt smartly.
Letâ€™s look at three real-life situations being heavily in debt, not in debt but contemplating taking a large loan, and being averse to debt, and ways to emerge as a winner in each of these situations.
Being heavily in debt
Have you immersed yourself into too many loans? Juggling between a car loan, home loan and credit card bills? How will you know if you have slipped into a debt trap? Here are a few warning signs which will tell you if you have reached the â€˜danger zoneâ€™ in your borrowings:
* You have little or no savings left;
* You pay the â€˜minimum amount dueâ€™ on your credit card bills;
* A major portion of your monthly income goes towards paying off your debts;
* You borrow from other sources to pay your current dues;
* Your checks have bounced a few times in recent past;
These are tell-tale signs that indicate how deeply you are stuck in debt. In such a scenario, the sooner you tighten your belt, the easier it will be to successfully shed the burden of debt. All you need is to get disciplined and follow a plan.
If you are servicing many loans, the ones that should be cleared off first are the high interest rate loans and those with no tax benefits. Personal loans and credit cards fall into this category. Also, if you have taken a loan against any assets such as equity or house property, then this one too should be a priority, since if you are unable to repay on time, the financer can take hold of your assets. The loans that you can service over a period of time include home loans and education loans since these offer tax benefits and carry lower interest rates.
If your existing loan comes with high interest costs, such as credit cards, you can consider taking a fresh low interest rate loan to settle high cost debts. For instance, taking a personal loan to repay your card out standings makes sense since credit cards attract steeper interest rates than personal loans.
If you are neck-deep in debt, you can cash your existing investments to pay off your loans. Investments bearing lower rates of return, such as fixed deposits, savings account balances can be withdrawn to clear off your dues. However, if your investments are earning good returns and repayments wonâ€™t be possible in a short time, it is best to leave these funds alone. If itâ€™s a temporary bad patch, you could look at borrowing from friends and family to tide you over loan troubles, rather than touch your assets.
One of the best ways to come out of the debt trap is to live moderately and prudently, cut down on unnecessary expenses, build up your savings and canalize your existing funds into repaying your high cost loans. Even if it entails living a frugal lifestyle for a while, do it.
Not in debt but contemplating taking a large loan you need to consider the following factors before you take on a loan
while borrowing comes with its own set of benefits.
Before you take on debt, you need to understand it first. One kind of debt is the debt you incur to fund an expense, which can be called consumption debt, for instance, taking on a personal loan to buy some consumer durable. The second is investment debt, where you take a loan to build an asset, for example, taking a home loan. There are situations where you could avoid using credit, such as making impulsive purchases, meeting luxury expenses.
Being averse to debt
Avoiding debt altogether can actually prove unwise at times, since the power of credit is tremendous. Credit helps you achieve tangible aspirations and let you build assets much earlier in life. Therefore, sometimes it makes sense to borrow. In fact, generally, major necessities such as buying a home or providing for education, merit borrowings.
As a rule of thumb, if you are averse to the idea of debt, you may avoid borrowing for frivolous purposes like a vacation, apparel, dining out at expensive restaurants, speculating and gambling, etc.
Sometimes borrowing is a close call. Items like furniture, appliances and certain home improvements fall into this category. Itâ€™s preferable not to borrow for such goods, but you may be able to justify the interest expense if youâ€™re buying items that youâ€™ll keep for 5-10 years or more.