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Watch out for excess debt

Keep all monthly repayments to less than 45 per cent of take home pay

Steven Fernandes 

After a long wait of three years, Tanmay (37) and Renu Gupta (35) finally got possession of their flat in November 2012. Since this was their first home, they decided that they will not cut corners in doing up their house. Finally they ended up spending Rs 6 lakh on the furniture and interiors. Having exhausted their entire savings on this house, the couple was forced to take a personal loan of Rs 5 lakh to fund the interiors bill.

Tanmay was already servicing two loans- housing loan of Rs 35 lakh and car loan of Rs 4 lakh. The latest personal loan ensured that the couple was spending around 59 per cent of their income in servicing all the loans, which left them with a small surplus comprising 16 per cent of their income. (See box)

The very fact that Tanmay has been working with the same employer for the last five years had given him a feeling of security and comfort which had resulted in the increasing pile of loans to cater to the family's various needs and aspirations. But a major calamity like a job loss at this juncture can leave Tanmay's family in disarray since he is the only earning member.

Nowadays, with increasing disposable income, most people have started spending more. A lot of times, people end up spending on things not be required or buying a product which may be quite expensive. To add to it is the comfort of buying your desired product on credit using your credit card. The problem with credit card is that one does not realise how much is being purchased on credit till the time the card gets blocked stating that the credit limit has been exceeded.

What are the implications

As a rule, one should restrict all the EMI's to less than 45 per cent of monthly take home income. The moment the limits are exceeded, we are inviting trouble in our lives. The savings component then suffers at the cost of instant gratification and it has a cascading effect on the future financial goals. Lower savings component would mean that either the income has to increase in order to allocate higher amounts for future goals or else face the prospect of not being able to meet your financial goals. Excessive borrowing coupled with some missed payments can potentially do a lot of harm to your credit rating which is monitored by credit bureaus.

Once your credit rating is affected, there are chances of your loan applications getting rejected in the future.

Excessive debt can also take its toll on your health as you are constantly battling to balance your expenses and EMI payments which can put you under tremendous stress. While debts are sometimes unavoidable but the quantum of debt can be controlled by us. So how does one avoid getting into excessive debts?

Plan your purchases in advance
It's advisable to plan your big purchases in advance and then start saving for it. For example if you are planning to buy a car, first decide your budget and then start saving for it.

If you do not have any other loan, then you might as well take a small loan to make up for the shortfall, but remember that the car will result in your overall expenses going up on account of fuel, servicing and so on. Don't club all your purchases at the same time to avoid putting stress on your finances.

Differentiate between good and bad loans
A home loan helps to create an asset and it comes at lower interest rates than other loans. It also qualifies for tax benefits which indirectly reduces your servicing cost. But other loans like auto loan and personal loan do not qualify for any tax benefits and on the contrary are available at higher interest rates. Credit card companies levy between 3.5 to 4 per cent per month on the unpaid balance which makes it the most expensive debt.

Don't compromise on your contingency fund
Do not empty your coffers to pay for your dream house or car. Maintain at least three months of expenses, including your EMI in your savings account. In families having a sole earning member, it's advisable to maintain six months of expenses in liquid form to take care of any uncertain situation.

Chief Planner, Proficient Financial Planners

First Published: Sat, March 16 2013. 21:28 IST