Golden Rules of Borrowing 4

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8 Immutable Rules of Borrowing

Can you remember your Childhood dream—“Become Older and Financial independent like your parents so that you can buy anything you wish to have, like-toys, chocolates and many more”. Yes, in our childhood, we live in a fantasy world where anything we wish, we can have that. But as we grow older, face the reality where many of us have to borrow to meet our goals.

We borrow to meet our goals but the improper borrowing structure can also ruin all of our dreams. Borrowing with lot of care is very important for our Financial planning as well as to get a secure Retirement life.

Today I’ll discuss with you about such immutable rules of borrowing that you should keep in mind while borrowing . Follow these rules and I am sure you’ll never find yourself enslaved by debt.

1. Borrow the amount which you can pay:

The very first rule of borrowing is that don’t try to copy other’s lifestyle : don’t live beyond your means.

We all have certain limitations. Know your limitations and don’t be ashamed to live as per your income. Your income may be low than your other friends/relatives , accept it. Don’t show off others because you’ll not be able to control your finances and will start careless borrowing and one day you’ll find yourself enslaved by debt.

Take a loan that you can easily repay. Here are rules on different types of loans

Borrowing percentage rules

Always keep in mind that your all loans together should not be more than 50% of your net monthly income.

Find out your Loan to income ratio today.
Loan to Income ratio= (Total EMIs/Net monthly Income)*100

Know the position of your current borrowing status from this ratio, take help of the below table:-

Optimum Loan to income ratio

2. Try to keep the Loan repayment Tenure as short as possible:

We all know that maximum the tenure, the lower is the EMI. Sometimes we all misled by this low EMI option. We buy a high priced items with a long tenure EMI. But have you noticed anytime how much extra you have to pay for this extra timeframe.

Yes, of-course, your EMI is low but you will be in awe if you calculate the amount you are going to pay over the periods.

Let’s take an example. Suppose you take a home loan of $30000 with 5% interest rate with a tenure of 30 years. This seems to look like very easy as you have to pay just $161 per month as EMI. But have you calculated over the years? Just watch the table

 

Borrowing table

In the 30 years, you are going to pay total $58000 where interest amount are 94% of your principal amount. ????????

Long Tenure Borrowing Chart

Taking a loan is just negative compounding. The longer the tenure, the higher is the compound interest which the bank is going to earn from you.

Sometimes, it may be necessary to go for a longer tenure EMI depending on situation. In this situation, the best option is to increase the repayment or EMI amount as soon as you get a hike in your income. If you increase your repayment every year then you’ll be able to become debt –free much before the predefined period.

3. Make timely and regular repayment:

Make sure that you are paying your dues on regular basis. Never miss a payment because a missing a payment can impact your credit profile.

Missed EMI is not only going to slap you with a penalty but it also signals to the banks/lending authorities on your inability to service the loan.

This is also true in case of credit card payment . Never ever miss the credit card bill. If in any month, you do not have the money to pay the entire credit card bill then pay at least more than 5% of the total credit card bill but don’t make it a practice. Because a high interest rate 20-30% may charge on your dues and this is the costliest loan you will ever take. Converting credit card payments into EMIs signals spending beyond your repayment capacity and it is dangerous for your Credit profile.

4. Don’t borrow for investing or Forex/stock trading purpose:

Being an Equity analyst, I’ve met some people who have borrowed money as personal loan to trade in the Future & option market. They believed that they would earn atleast 50% from the F&O market in a year and would make repayment the loan @12 % interest rate . The difference would be their profit.

It sounds good. But in reality it is not possible because you may incur loss from the trading also. Then you’ll be trapped in the loan amount.

So, never borrow money to invest. In case of ultra-safe investment like FD, bonds; you’ll not be able to match the rate of interest you pay on the loan.
So, it is always advisable not to borrow money for investment purpose.

5. Take insurance with the Big loan:

If you take high amount of home or car loan then it is best to take an insurance cover as well.

Buy a term plan of the same amount to ensure that your family members do not have to face any unfavorable situation if something happens to you. Because the lenders (banks) will take over the asset if your family members/dependents unable to pay the EMIs.

6. Understand the terms and conditions:

Always read the loan documents carefully. They are not for light reading. Read all the terms and conditions and if you are unable to understand any of the rules then asked for expert -help.

7. Substitute high cost loan, if possible:

If you have many loans in hand currently then try to consolidate your all debts under one omnibus low cost loan.

Or, make a list of all of your loans and find out the costliest one then try to substitute that with a low cost loan or pay this costliest loan as soon as possible.

Sometimes, we avoid ending our loan amount as we are getting some tax benefit. Yes, we may get some tax benefit in some type of loan interest payment but this tax benefit should not be the only reason of loan running. Because you are still incurring a expense and this will only stop when you will prepay your debt fully.

8. Keep aware your family members about your loan amount:

Before you take loan, discuss with your family members , especially with your spouse. Because this loan amount and its repayment will impact on your personal finance management.

Keeping a spouse in the dark on the money matters not only increases the stress in your marriage but also you may lose any other cost effective solution. Your spouse may have any better idea or may have some spare cash in hand and this may help you avoid taking loan.

So, always keep your family members aware about your personal financial plans.

Conclusion

Loan is not good for anybody but sometimes it becomes necessary to take loan. It is always advisable to compare interest rates from several organized lenders before you take a loan and read the loan documents carefully. Try to follow each and every rule discussed in this article. I hope if you follow these rules then you’ll never find yourself trapped in a debt circle.

Have a Debt-free Life.

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About Moonmoon Biswas

Moonmoon Biswas is an Equity research analyst . She has more than 10 years of experience in this field. She has proven track record in the field of Technical analysis and the Fundamental analysis. From the educational background, She is an MBA-Finance with CFA (India). She has work experience in the leading broking houses in India and has also in hand experience in Australian Security Market. She has her own equity research firm and currently also engaged in digital marketing.


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