1. DON’T BORROW MORE THAN YOU CAN REPAY
The first rule of smart borrowing is what the older generation has been telling us all the time: don’t live beyond your means. Take a loan that you can easily repay. One thumb rule says that car EMIs should not exceed 15% while personal loan EMIs should not account for more than 10% of the net monthly income. Your monthly outgo towards all your loans put together should not be more than 50% of your monthly income. With banks falling over each other to attract business, taking a loan appears as easy as ABC. But 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. Make sure you don’t commit this mistake.
2. KEEP TENURE AS SHORT AS POSSIBLE
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. In a 10-year loan, the interest paid is 57% of the borrowed amount. This shoots up to 128% if the tenure is 20 years. 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.
3. ENSURE TIMELY AND REGULAR REPAYMENT
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. Never miss a loan EMI even if it means missing other investments for the time. In an emergency, prioritise your dues. You must take care never to miss your credit card payments because you will not only be slapped with a non-payment penalty but also be charged a hefty interest on the unpaid amount.
4. DON’T BORROW TO SPLURGE OR INVEST
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. Similarly, avoid taking a loan for discretionary spending. You may be getting SMSs from your credit card company for a travel loan, but such wants are better fulfilled by saving up.
5. UNDERSTAND THE FINE PRINT
Loan documents don’t make for light reading. Paragraph after paragraph of legalese printed in a small font can be a put off. Yet, read the terms and conditions carefully to avoid unpleasant surprises.
6. KEEP SPOUSE, FAMILY IN LOOP ABOUT LOAN
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.