My money: How to manage debt

Sanjay Khurana

penny saved is a penny earned. It always holds true. We all want to lead a debt-free, and in turn a stress-free, life. But, with rising inflation, surging real estate prices and the high cost of living, it’s easier said than done. As loans are easily available, literally for everything, the importance of debt management cannot be overstated. Take a loan only for big aspirations such as buying a house or higher education of yourself or children.

These days, one can even go on a holiday on equated monthly instalments or EMIs. These are debt traps, and once you get into the split-and-pay scheme of credit cards, it is almost impossible to get out of that cycle as the banks charge approximately 42 per cent interest rate per annum on such loans. Always pay your credit card bills and loan EMIs on time.

First of all, let’s understand that all debts are not bad. Many people believe having no debt is ideal, but there are situations when debt can actually be considered good if it helps in creating assets. For example, if you don’t have sufficient money to buy a house, you can go in for a loan to acquire one. This will help you in creating an asset. However, the debts which are taken to acquire depreciating assets such as luxury cars, expensive clothes, consumables, white goods and shopping through credit cards is not at a good idea.

What is good debt

A loan for business, house or education may be considered a good debt because it can benefit your long-term financial health. Some of the examples of good debt are:

Home loan: It helps in creating an asset which can be a source of income if the property is rented out or helps in saving you from high rentals. The value of property will also appreciate over the years while the EMIs of the loan amount will remain the same.

Education loan: It helps in enhancing one’s earning potential. Better education can help you get a lucrative job, thus improving your standard of living and future prospects.

Business loan: The loan taken for starting your own venture can also be considered a good debt as it helps in multiplying your wealth.

What is bad debt

Bad debt is generally a loan that you take to purchase a depreciating asset such as buying an expensive car, electronic gadgets or to fund impulsive purchases. Though the EMI on car loan remains the same over the years, the value of the vehicle keeps on depreciating, besides increasing your recurring expenditure on wear and turn, servicing, insurance and fuel expenses.

To avoid such loans, using a cab or public transport makes much economic sense, especially in big cities. It also helps you in getting a car with a driver without parking hassles, which has become a major nuisance these days. Some of the examples of bad debt are:

Loan for consumables: Taking a loan or using your credit card beyond limits (by paying in EMIs) for buying expensive branded clothes, extravagant furniture, white goods and other consumables may not be a good idea. Such impulsive purchases on credit card or by taking a personal loan is not a good debt.

Use of credit card: Though it’s very convenient to use credit cards for making purchases, it’s not always advisable unless you can make the payment in lumpsum. Deferring your credit card payments by the split-and-pay method is not recommended and should be used only in case of emergency.

Credit card reward programmes give cardholders an extra incentive to spend. But unless you pay your balance in full every month, the interest charges (as high as 42 per cent per annum in most cases) may more than offset the value of your rewards.

Timely repayment

To live a stress-free life, timely repayment of loans is crucial. First of all, make a note of all your loans and set a timeline for priority repayment. If you have debts, you must make a monthly budget of your income and expenses. This will help you in calculating all your recurring expenses and making monthly payments in time. Then, you can work toward identifying which debt you should clear first and allocate extra funds for it.

You can also use debt consolidation. With this strategy, you take a new loan at a lower interest rate to pay off your other loans with a higher interest rate. In this way, you can repay your loans faster and save on the overall interest.

Keep track of accounts

It can be challenging to track details when you have multiple loans. But financial planning is a must to get rid of loans as soon as possible.

Try to understand the minimum amount that you need to pay for every loan. This will help you in organising your debt. While you are at it, don’t forget to make your credit card payments on time as their interest rates are higher than most loans. If you miss paying your credit card bills on time, your debt may inflate significantly and land you in trouble.

If you don’t have a monthly budget, you can’t have control over your finances. With the right budget, you can not only keep a tab on your spending, but also ensure that you never land yourself in debt again. There are several user-friendly apps that you can use to track your spending. The best way is to divide your expenses into different categories such as groceries, fuel, food, monthly bills, house rent, loan EMIs, dining out and entertainment.

Debt with highest interest rate

Identify loans with the highest interest rate. It raises your overall liability. When you pay your monthly instalment, a significant amount goes towards your interest and not the principal amount.

Experts say we should organise our loans in the decreasing order — start by clearing the first loan and then move on to the others in that order. This will always help in saving money in the long run.

The ideal way is to pay a little more in the first loan account in your list and the minimum payable amount in the remaining. You can also set auto payments to ensure that you don’t miss your payments. During this process, don’t forget your other loans. Keep paying their minimum instalments to avoid penalty and interest on it.

Avoid more credit

This whole exercise of repaying your debt will be futile if you resort to taking more loans. Avoid using your credit cards because they make it easier to make impulsive purchases and switch to using cash or debit cards. When you pay in cash, you spend what you have. Secondly, you also understand how much money you have in your account. It helps in making wiser decisions.

Emergency fund

Creating an emergency fund is also very important. Ideally, there should be an emergency fund that can meet your regular expenses for at least six months. Better money management such as regular savings, systematic investment plan and cutting down on unnecessary expenses will definitely help in improving your personal finance.

The path to better finances starts with changing your habits. Some of these changes will be easier than others, but if you stay committed to this transformation, you’ll end up with great money management skills that will serve you throughout your life and you will have more money in your pocket.