Experts say debt usually has a major impact on emotions. Mounting debt can bring stress and unhappiness. However, the good news is if you deal with it systematically, you can get out of the trap sooner than you expected. If you are one of those who has been struggling to pay loans or have too many credit card payments left to make, financial planners tell you how to deal with it.
Most expensive loan first
If you have multiple loans and don’t have the money to service all at once, start with the most expensive one. “Pay the loan which has the highest interest rate first. For example, credit card followed by personal and education loans,” said Deepali Sen, a certified financial planner and founder of Srujan Financial Advisers LLP.
Are you wondering why credit card? “Among all loans, revolving credit on credit card is the most dangerous one. Credit card companies will give you the option to pay minimum amount instead of the full amount due. Once you get into the habit of using credit cards by paying the minimum amount, your free credit period is over. For all purchases from next month, you will be paying interest at the rate of 36-48% a year, depending on credit cards, from the date of purchase. Your existing outstanding will also attract interest at these rates. If you continue to use the card, it will be tough to get out of the trap,” said Melvin Joseph, founder, FinVin Financial Planners.
If you get any kind of surplus, use it to close a loan as fast as you can. “Keep increasing the equated monthly instalment every year by at least 8-10%. Prepay in chunks from your annual incentive. Take on as lower tenure as feasible. For a 20-year tenure loan, for the initial 3-5 years, only 18-20% of the EMI goes towards principal payment. Shorter the tenure, higher the EMI, higher will be the percentage of principal payment. The earlier the loan is over, the faster you can retire, take a sabbatical or become an entrepreneur if that’s on your wishlist,” said Sen. However, that doesn’t mean you should not invest. “Use at least 50% from annual increment to increase the EMI. The remaining 50% can be used for building on investments for impending goals,” said Sen.
People take personal loan for emergencies as they don’t have investments for short-term needs. “Everybody should create an emergency fund of their expenses for six months. This can be used in case of any emergency such as hospitalisation. If you don’t have the fund, you will be forced to resort to a high-cost loan, which can derail personal finance. Prevention is better than cure. In case of a financial emergency, adjusting your lifestyle is very important. If you are into heavy debt, there is nothing wrong in cutting short on some basic luxuries. Otherwise, your basic needs will be affected in the near future,” said Joseph.