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| Buy now, pay later and repent at leisure |
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Rattan Chugh
ExpressMoney
What can you do if you are overborrowing? Rattan Chugh explains how you can determine your borrowing limits.
We live in the world of “Buy now, Pay later”. Almost every consumer product can be bought for an equated monthly installment (EMI) which is a fraction of the (MRP). Every real-estate developer and car dealer has a financing arrangement tied-up upfront.
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A few years ago, banks stringently refused you a loan even if you had a regular monthly income. Today you are inundated with calls on your mobile phone for personal loans and loans against property. Easy access to loans lures us into buying a fancier car, own an elegant plasma television or travel to an exotic holiday destination in Europe, but in the process we fail to take stock of our financial health and may get trapped into over-borrowing. |
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When you spend now and pay later you are leveraging your future income. There are a couple of questions to consider: First, what if for some reason the future income stops. How will you service your EMIs if you loose your job? In the instance of untimely death of the borrower, the dependents will be liable to square off the loan. It may be worth while to take adequate insurance to cover the liability. Secondly, what are you borrowing for? Is it to acquire an appreciating asset such as buying a house to live in or promoting your career by going for higher education or is to buy a luxury item and support an extravagant lifestyle? Consumer debt is a dangerous spiral which is very hard to get out of. |
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| How much loan is ok? |
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How much can you afford to borrow, is the question everyone faces. Typically, not more than 25 % of your income should go towards servicing your loans. Here, I have assumed that 50 % of your income goes towards your expenses and other liabilities and 25 % towards saving for your medium to long term goals. To illustrate, if your take home salary is Rs. 60,000 per month, your EMI payments should not exceed Rs. 15,000. As you might expect, there are exceptions to the 25-percent rule.
If you are in an early stage of your career and residing with parents, not having significant monthly expenses and probably having a rather small take-home paycheck, might justify a larger monthly payment. If one spouse earns far more than the other, the one with the smaller paycheck can easily break the rule. If you have a home loan going, 30-35 % of your income can go towards servicing loan EMIs. The higher amount in permissible because a house is your biggest life spend and an appreciating asset. |
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| And for what tenure? |
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Choosing the tenure of the loan wisely is equally important. A higher tenure enables you to reduce the EMI but it increases the interest burden. The greater the EMI you are willing to pay, the greater your interest savings. For example, if you take a loan of Rs. 5 lakhs at 15% interest per annum for five years, you will pay over Rs. 2 lakh as interest. If you can manage to reduce the tenure from five years to three, you can save about Rs. 89,000 which is 43% of your interest. See the chart for incremental interest cost for every additional year. |
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Lastly, check whether you have pre-payment and step-up options. As your salary increases over the years or you get a bonus you may like to pay the whole or a part of the balance loan and save your expenses on interest. You may like to reduce the tenure and increase your EMI. |
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The writer is CEO, Cornerstone Wealth Management
rattan.chugh@cstone.in
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