Economic Times, 21/12/15, source: http://economictimes.indiatimes.com/wealth/borrow/golden-rules-of-borrowing/articleshow/50243359.cms
In an ideal world, everybody would have enough money for all his needs. In reality, many of us have little option but to borrow to meet our goals, both real and imagined. For banks and NBFCs, the gap between reality and aspirations is a huge opportunity. They are carpet bombing potential customers with loan offers, promising low rates, quick disbursals and easy processes. While technology has altered the way loans are being disbursed, the canons of prudent borrowing remain unchanged.
We list nine immutable rules of borrowing that potential customers must keep in mind.
DON’T BORROW MORE THAN YOU CAN REPAY
Don’t live beyond your means. Take a loan that you can easily repay. One thumb rule says car EMIs should not exceed 15% while personal loan EMIs should not account for more than 10% of the net monthly income. If your EMIs gobble up too much of your income, other critical financial goals might get impacted.
KEEP TENURE AS SHORT AS POSSIBLE
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. Increasing the EMI amount can have a dramatic impact on the loan tenure. If a person takes a loan of Rs.50 lakh at 10% for 20 years, his EMI will be Rs.48,251. If he increases the EMI every year by 5%, the loan gets paid off in less than 12 years. If he increases the EMI by 10% every year, he would pay off the loan in just 9 years and 3 months. ENSURE TIMELY AND REGULAR REPAYMENT
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.
DON’T BORROW TO SPLURGE OR INVEST
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 such as equities are too volatile. Similarly, avoid taking a loan for discretionary spending. On the other hand, taking a loan for building an asset makes eminent sense.
TAKE INSURANCE WITH BIG-TICKET LOANS
If you take a large home or car loan, it is best to take insurance cover as well. Buy a term plan of the same amount to ensure that your family is not saddled with un- affordable debt if something hap- pens to you. The lender will take over the asset (house or car) if your dependents are unable to pay the EMI.
KEEP SHOPPING FOR BETTER RATES
Keep shopping around for the best rate and switch to a cheaper loan if possible. However, the difference should be at least 2 percentage points, otherwise the pre- payment penalty and processing charges will eat into gains.
READ THE FINE PRINT
Read the terms and conditions carefully to avoid unpleasant surprises. If you are unable to understand the legalese, get a financial advisor or chartered accountant to take a look.
SUBSTITUTE HIGH COST LOANS
If you have too many loans running, it’s a good idea to consolidate your debts under one omnibus low-cost loan. It is also a good idea to prepay costly loans as soon as possible. Divert windfall gains towards repayment.
DON’T NIX RETIREMENT BY AVOIDING LOANS
Dipping into your retirement corpus to fund your child’s education can be risky. Students have options like loans and scholar- ships to cover their education costs but there is no such arrangement to help you plan your retirement needs. Your retirement is as important as your child’s education.
(This article is a condensed version of one originally published on September 14, 2015, and may contain chronological references based on that date.)
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