Almost everyone at some point of time in their life needs a loan. While a school of thought exists that loans are bad, this is not entirely true. While essentially, a loan means borrowing money to fulfil your requirements and in that process, paying an interest when repaying the same over a number of years. It should be treated as a bridge between your requirement and your current inability to find it on your own.
Consider opting for loans which helps you to make more money rather than, loans which just help finance wasteful expenditure. In the end, any loan that provides new avenues of income and creates a tangible asset whose value does not decrease over time is considered good debt. Everything else is not desirable or simply put are bad loans.
Before you take on any debt, consider whether the loan will help meet your financial goals — or cripple them. The kind of debt you take on, along with its quantity and cost, can mean the difference between good debt and bad debt. When a lender looks at your credit report to see what kinds of accounts you have, they'll look at some debts more favourably than others. If you’re focusing on getting out of debt, you first need to understand which debts are considered bad and which are considered good. That way, you can prioritize your debts so that you get rid of the bad ones first.
The first rule of smart borrowing is don't live beyond your means. Take a loan that you can easily repay. Don't take a loan just because it is available. Make sure that your loan-to-income ratio is within acceptable limits. If your EMIs gobble up too much of your income, other critical financial goals, like saving for retirement or your kids’ education, might get impacted. Retirement planning is often the first to be sacrificed in such situations.
The maximum home loan tenure offered by all major lenders is 30 years. The longer the tenure, the lower is the EMI, which makes it very tempting to go for a 25-30 year loan. However, it is best to take a loan for the shortest tenure you can afford. In a long-term loan, the interest outgo is too high. "Taking a loan is negative compounding. The longer the tenure, the higher is the compound interest that the bank earns from you,” Sometimes, it may be necessary to go for a longer tenure. A young person with a low income won’t be able to borrow enough if the tenure is 10 years. He will have to increase the tenure so that the EMI fits his pocket. For such borrowers, the best option is to increase the EMI amount every year in line with an increase in the income. Increasing the EMI amount can have a dramatic impact on the loan tenure.
It pays to be disciplined, especially when it comes to repayment of dues. Whether it is a short-term debt like a credit card bill or a long-term loan for your house, make sure you don’t miss the payment. Missing an EMI or delaying a payment are among the key factors that can impact your credit profile and hinder your chances of taking a loan for other needs later in life. In an emergency, prioritise your dues. If you don’t have the money to pay the entire credit card bill, pay the minimum 5 percent and roll over the balance. To avoid missing the due date every month, just give standing instructions to your bank to pay the minimum 5 percent amount whenever the bill is due.
If you have too many loans running, it's a good idea to consolidate your debts under one omnibus low-cost loan. Make a list of all outstanding loans and identify the high cost ones that can be replaced with cheaper loans. A loan against property can be used to repay all other outstanding loans. It is also a good idea to prepay costly loans as soon as possible. Borrowers sometimes avoid ending loans because they offer tax benefits. But this tax benefit alone should not be the reason to keep a loan running. True, the tax benefits bring down the effective cost of the loan. Unless the money can earn you a better return than the effective cost of the loan, use it to prepay the outstanding sum.
Before you take a loan, discuss it with your family. This is important because the repayment will impact the overall finances of the entire household. Make sure your spouse is aware of the loan and the reasons for taking it. Keeping a spouse in the dark on money matters not only increases stress in a marriage but also precludes your chances of finding a more cost effective solution. Maybe your wife (or husband) has some spare money which can help you avoid taking the loan altogether. Don’t miss out on that opportunity by keeping your need under wraps.
This is also one of the basic rules of investing. Never use borrowed money to invest. Ultra-safe investments like fixed deposits and bonds won’t be able to match the rate of interest you pay on the loan. And investments that offer higher returns, such as equities, are too volatile. If the markets decline, you will not only suffer losses but will be strapped with an EMI as well. On the other hand, taking a loan for building an asset makes eminent sense.
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