Who wouldn’t want to live a debt-free life?
This image below aptly depicts what I would need thousands of words to explain 🙂
But let us be fair – at times, loans are unavoidable.
You just have to take some external help to manage your personal finances and expenses.
These days, very few people would be capable of purchasing houses without taking home loans – reason being the sky-high property prices and the sad reality of the Indian property market. Then there are personal loans for people who need money for various other reasons. And credit cards – remember them too!
It is easy for us to say that loans should be avoided. But without knowing the borrower’s background and personal situation, we really cannot judge whether they are taking loans unnecessarily or whether they are doing the right thing.
Historically, we have been a society of savers.
But things are changing now. There is a generational shift in how the newer generation views debt. I read an interesting article recently on this issue (link). India’s household debt to GDP has moved up from 11.2% in FY12 to 15.7% in FY18. And this trend is expected to continue as there is an attitudinal shift towards loans among the younger lots. And here is another interesting fact, current Household Debt to GDP of 15.7% is way below the emerging market average of 39%.
So atleast theoretically, we may continue to see this ratio inch upwards as we transition from being a hard-core savers’ society to one which is more comfortable saving a little less and taking loans for preponing their expenses.
Will this transition lead to an eventual crisis like the over-leveraged societies of developed nations?
Maybe yes. But that is something which you or I cannot predict in the near term. So no point deliberating on it. Let’s cross the bridge when it comes.
Earlier, loans were treated like a disease. But now, they are being perceived as nutritional supplements. 😉
I remember that when one of my young clients approached me for financial planning and investment advisory, I was shocked to see how he was treating debt like the working capital of his personal finance!!
At times, I am surprised to see how many young people (including some of my friends) are trying to tackle huge credit card bills, personal loan EMIs, car loan EMIs and yes…. Home loan EMIs.
Some feel ok living like that. But others repent their choices day in and out as they end up arm-twisting themselves into a debt filled life. Its like they are earning money just to pay their EMIs and bills.
But let’s move on…
How to close your Loans and Live Debt Free?
Now we are talking. 🙂
You have credit card bills, personal loan EMI, car loan EMI and a home loan EMI. Did I miss anything? Maybe an Education Loan EMI as well.
How are you feeling?
No need to answer. I know it. You know it. And worse, your family members can sense how you feel about it.
See the basic principles of how to close all your loans is no secret. You know it too. But most people end up taking a lot more loan than what they should be doing. Home loan (and even a car loan) I understand can be justified. But others are more about spending problems – not being able to stop yourself from spending beyond your means.
And I hope you realize what happens when a major chunk of your income goes towards loan EMIs. You already have non-negotiable household expenses to tackle. This leaves very little or no surplus that can go towards savings and investments for your financial goals.
God bless the government that forces people to save via EPF, etc. Had it not been for them, many young people would literally have no savings at all! These people are most vulnerable to ‘being just one unplanned expense away from financial disasters’.
Now make 2 lists.
First one listing down all your loan details as given below:
* The figures used above are random.
This list will clearly show you where you are in relation to your debt.
Now make another list as given below:
This list tells you how your income comes and goes out. In the above particular situation, the person is basically broke at month end and is living paycheck to paycheck.
And if you still haven’t noticed, then let me highlight that there is no row for savings in the 2nd table. That is because the person has put himself in this situation of not being able to save for his real financial goals. He (it seems) is planning to take one side of the payoff loans or invest for future kind of debates.
The sad result of this inability to save is the dramatic loss of compounding which comes with delay in investing.
But that’s how it is for many people – Earning well. High expenses and EMIs. Almost no savings!
So with data in front of you (in two tables), what should you do?
For practical reasons, try to pay off the smallest loan first. In this particular scenario, it is also the highest-interest bearing loan (i.e. credit card), so this makes all the more sense.
Now you will ask, how should you prepay it when there is no surplus left at the end of the month?
The answer to this question is to figure out a way to generate that surplus from somewhere.
How do you do it?
If you can increase your income quickly, then that’s great. Else – Reduce your expenses somewhat My Lord! 🙂 That’s how elementary it is!
I know it is difficult for you to do and easy for me to say.
But you have to do it Sir!
More so, if you can spare some money from your existing assets (let’s say money in fixed deposits or savings account), then use it too. But do keep some money for emergencies as well.
So that takes care of your one EMI.
One loan closed!
And since the loan is closed, you have more surplus money as the EMI for that particular loan is not needed to be paid.
Now what to do?
Take the next smallest loan or higher-interest cost loan and begin prepaying it.
Repeat this again and again. That’s how you do it. After each loan closure, your monthly surplus will increase (due to EMI elimination).
I don’t think most people are comfortable taking money from friends and relatives. But if it works for you, then you can take some and pre-close a small loan. Up to you.
Remember that you should first try to get yourself free of at least credit card debt and personal loan debt. Once these two are tackled, you should think about clearing your car loan and then the home loan (that you took to purchase your properties). But whatever you do, please do not default on your EMI payments of any of your loans. It will hurt your credit score and your ability to get loans in the future.
I am repeating this but when you begin this exercise, reducing your expenses is very important.
Just for some months, give up on your worldly pleasures and tackle the loan problem. Once you have closed one of your loans, automatically your surplus would increase and I would not pester you to reduce your expenses 🙂 You can begin living in ‘today’ again.
Ultimately, this combination of controlled expenses, reducing EMI outgo leading to higher surplus and income hikes will allow you to be in a comfortable situation.
This would then allow you to invest and save properly in a structured manner – goal based investing. And believe me, this approach will make you feel in total control of your finances.
So that’s how you can begin your journey of a debt-free life. Simple but maybe not so easy. But do it nevertheless. It will be worth it.
Now let’s discuss briefly some points that should have been tackled earlier itself.
How much loan EMI can you afford?
This is the question that should be asked before you start applying for your multiple loans. 🙂
Ofcourse there is no perfect answer.
But your income is limited and with regular expenses to take care off, there is a limit to how big EMI(s) you can afford.
Different people having different loans will ask a different version of this question. Like:
- How much Home Loan EMI can I afford?
- How much Personal Loan EMI can I afford?
- How much Car Loan EMI can I afford?
- I already have a car loan. Now how much Home Loan EMI can I afford?
- I already have a home loan. Now how much Car Loan EMI can I afford?
- I already have a home loan and a car loan. Sh**! But I also need some more money urgently due to an emergency. So how much Personal Loan EMI can I afford now?
Different situations, same concern – Due to limited income and growing expenses, what is your loan EMI affordability?
The lenders (banks, NBFCs in collaboration with credit rating agencies) help you in this regard somewhat.
These lenders ensure that EMIs for all your loans combined do not exceed 40-45% of your take home salary.
But problem is that they don’t know about your expenses and other off-book financial commitments.
So if your non-EMI based expenses are too high (like 70%) and bank doesn’t know that, then even if bank is willing to give you a loan of EMI equal to 40% of your income, you yourself will be stupid to take such a loan as your EMI+Expenses would far exceed your Income. That would be a financial disaster unless you can cut down your expenses drastically.
And ideally, you also need to save for the future too. And saving a very small amount – like saving 10% of your income might not be enough.
So you need to be prudent about how many and how much loan you take.
There is a limit to what you earn. There is a limit to how much you can reduce your current expenses to accommodate the loan EMIs. And there is a limit to how much you should compromise your savings and investments to repay the loan.
So do not get attracted unnecessarily towards easy availability of loans to spend on discretionary material possessions.
Taking loans is inevitable for most people.
But remember that no matter how easily you get a loan, the fact is that you and no one else has to pay it back. So gradually, make a conscious decision and work towards a debt-free life to build your case of achieving financial freedom at the earliest.
Good write up Ashish. It would be good to provide a % of income that people should look to save as a benchmark
Higher the better. There is no one rule that applies all. I saved 90% of my income during my early days of carrier and invested in Mutual funds. You won’t believe me, I retired at 37.
Avoiding debt at all costs might not be the best approach. There’s good debt and there’s bad debt. Rich dad poor dad taught me that 🙂
If you use debt to leverage your investments, such as buying a rental property it can help you reach your goals a lot quicker.
Thanks for sharing this great post