Short Term Personal Loans – To take or Not?

Short Term Personal Loans India

After the recent fall in stock markets, I have (once again) started getting emails asking whether it makes sense to take a loan and invest now. 🙂

This isn’t surprising. Whenever markets start falling or remain subdued for some time, I start getting similar emails from ultra-aggressive investors.

And as if its Loan God’s wish, it’s pretty common these days to get unsolicited mailers in your inbox about pre-approved loans. To be honest, the idea seems tempting to take the loan and invest it. But I don’t do that. Borrowing to invest in volatile assets like equity is extremely risky. In fact, it’s a recipe for many stories of financial disasters.

Now before I simply brush aside the idea of investing on borrowed funds, let me also say that the idea of borrowing to invest itself is not bad. It is just a very risky one and not suitable for most investors. Most people who are attracted to it don’t really understand the dynamics of it.

So I strongly urge you to stay away from investing with borrowed money.

It is easy to get lured by the charm of earning handsome returns doing that. But equity markets don’t move in a straight line and more importantly, don’t deliver returns on demand. They have a mind of their own.

So there is no guarantee that you will get profits. On the other hand, loans are fairly predictable. You have to repay your personal loans without fail and on time. 🙂

To put it more aptly, there is a sheer mismatch in the common tenure of personal loans (short term) versus suitable tenures that are needed to ensure good returns from equity (long term).

For the majority of people (and I am repeating) – they shouldn’t borrow and invest in equity markets.

If you really want to build wealth, it’s better to take the gradual and stable route – invest in well-diversified equity funds via monthly SIPs towards your financial goals. That’s a far surer way to accumulate wealth in the long term.

So with that aside, let’s get to the question about what should the short-term Personal Loans be taken for?

Again, it’s easy for me to say that you should not take personal loans and you should plan for your money needs in advance. For obvious reasons, nobody would borrow money if they could avoid it. Isn’t it? But life has its knack of surprising us.

People will have unexpected needs and emergencies and they will take loans.

If you need the money and don’t have it, then depending on how comfortable you are, chances are that you might first ask your friends or family to lend you some money. In most cases, they won’t even charge any interest. But many people aren’t comfortable doing that. The next option is the loans.

So let’s see what all factors should be considered before you take that short-term personal loan:

Important things to consider before taking Short Term Loans

1) Getting a Low Personal Loan Interest Rates

I know – the first question that comes to mind of borrowers (after thinking how are they going to repay it) is how to get the Lowest Interest Rate on Personal Loan?

This is actually a no-brainer. Lower the loan rates, better it is for you.

But at times, you may even have to accept higher rates if the loan amount you need is available from a lender who is charging slightly higher.

Now here is an important thing. When making the decision, don’t just look at the interest rate being offered. There are other things to consider too. Do read the fine print or ask the lender whether the loan is being given on a flat-rate basis or a reducing-balance basis. This is one thing. Another is that the interest cost is not the only cost that you have to pay. There are other charges like Processing Fee (Lower the better) Prepayment Fee (again lower the better) Late Payment Fee (any guesses?)

So basically, the total landed cost of the loan (which is not just about the loan rate) should be the minimum for you.

Now personal loans are unsecured loans. That is, they don’t take any security from the borrowers. So naturally, the rates will be high. But if it’s possible for you to provide some security (like LIC policies, precious metals, other savings, etc.) and make it a fully or partially secured loan, then the lender would very easily reduce the loan interest rate by few percentage points. And that can help you a lot.

2) Getting the Optimal Loan Amount

If you need a personal loan for a specific reason, you would already know how much money you need.

But what happens is that lenders try to entice borrowers to borrow more than what they actually need.

Please don’t do that.

Just because you can avail a bigger loan, don’t go overboard. Take a loan of as small an amount as possible. If you need a loan of Rs 2 lac, then take a loan of Rs 2 lac or lower even if someone is willing to lend you Rs 5 lac.

A loan is a loan and you need to pay interest for what you borrow. And you don’t want to pay interest on the money you don’t need.

3) Loan EMI and Tenure

The maths of personal loans (or any loan) is such that the tenure selected along with the loan amount and the interest rate determines your final EMI.

How much EMI you should opt for?

To be honest, you yourself are the best judge. No one knows about your repayment ability better than you. 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. EMIs have to be paid month-on-month and without fail. It’s not an option but an obligation.

Do an honest assessment and chose the EMI which is affordable and comfortable for you to manage during the full loan tenor and not just initially.

So first find out what EMI you can comfortably manage first. And then manipulate the loan tenure and/or the loan amount to arrive at an EMI that is affordable for you. There are several free personal loan EMI calculators available online. Try them out. These loan calculators not only show the loan EMI but also tell you the total loan interest payable throughout the loan tenure.

And if you feel that the lowest EMI is the best one possible for you, then let me tell you that it may be comfortable but it is not the best.

Ideally, you should try to keep the repayment period as short as possible. The reason is that it will reduce your total interest burden during the loan tenor.

Although your EMIs for a short-tenor loan would be higher than a longer-tenure loan, it makes mathematical sense to reduce your total interest outgo. Here is a small example to help you understand this – Suppose you avail a personal loan of Rs 5 lakh at an interest rate of 16%. Then your total interest paid over the loan tenor would be as following:

  • 5-year Tenor – Rs 2.29 lakh
  • 4-year Tenor – Rs 1.80 lakh
  • 3-year Tenor – Rs 1.32 lakh

Ofcourse, you need to consider EMI affordability too, which changes with loan tenor:

  • 5-year Tenor – EMI of Rs 12,159
  • 4-year Tenor – EMI of Rs 14,170
  • 3-year Tenor – EMI of Rs 17,579

But I hope you understand what I am saying. If you can increase your EMI a bit, you can easily save a lot of money on interest. I did a similar analysis for home loans. You can read how shorter loan tenor reduces total interest outgo for home loans.

Once you have taken a short-term personal loan, you need to understand that you should regularly pay your EMIs. It’s not just because lenders want you to do that. It is also because your credit score can be improved by smart repayment of these short-term personal loans.

The credit score is used by lenders to evaluate your capacity to pay the loan on time. In general, higher your credit score is, the better chances you have of loan approvals. So how does a personal loan help improve credit score? When you take a small loan, it’s easier to repay than a large loan. So you can easily pay off all your EMIs on time (remember always go for affordable EMIs to ensure this). Once you do that, it incrementally improves your credit score.

And I don’t need to tell you why having good credit or cibil score is important. Sooner or later, you will take big loans – like a housing loan.

At that time, lenders will check your credit score and history. So having a good score will work in your favor and increase the chances of loan approval. And as things are expected to pan out, the borrowers with a higher score will get loans at slightly lower rates than those who have a lower credit score. This in itself means that one can save a lot of money in lower interests.

For example – suppose borrower A and B both need Rs 75 lac home loan. Due to a higher credit score, the bank is offering a home loan to A at 9%. Whereas the same loan is being offered to B at 9.5%.

Can you guess what is the cost of this difference over the course of the loan (assuming 25 years)? The total additional interest paid by B will be about Rs 7.5 lac.

So having a high credit score when you are taking bigger loans can save you a lot of money. If you do not have any credit history, then you can even consider taking a credit card against a fixed deposit and build up your credit score slowly.

Enough said…

I said this earlier and will repeat it again – it’s easy for me to write here that one shouldn’t take personal loans. But practically speaking, people will need to borrow and they will. So might as well be smart about it and manage the personal loans well.

If loans are taken for genuine unplanned emergencies, then its fine and make sure that you do consider interest rates, charges and convenience. But do not borrow to invest in stocks. Please don’t do it. 🙂

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Don't take Advice from Banks

Why shouldn’t You ask Banks for Investment Advice?

Don't take Advice from Banks

The banks in India mis-sell financial products.

Intentionally or unintentionally, they do it. And there is no other (softer) way to say it. Even the regulator RBI now accepts it.

And if you want to experience mis selling by Indian banks first hand, it is very easy.

Just walk into your bank’s branch and tell them that you have ‘more’ money and want to open a fixed deposit. They will surround you like vultures and try to push some product or the other, irrespective of whether you need it or not.

I don’t want to sound rude to our bankers but this is what really happens. That’s how most Indian banks are structuring their businesses – to maximize their incomes from non-banking activities even if it leads to mis selling of financial products.

What exactly is Mis-Selling of Financial products?

Mis-selling means any sale of financial products by any person (directly or indirectly) by:

  • Making a misleading or false statement, or/and
  • Not taking reasonable care to ensure suitability of the product to the buyer, or/and
  • Concealing or omitting material facts about the product, or/and
  • Concealing the associated risk factors of the product

Now mis-selling can be deliberate or unknowingly. But the end result is that the mis-sold products are either unsuitable for customer’s needs, are misrepresented or are too complex to be understood by the customer.

The problem of misselling is systematic and unfortunately, deeply embedded in the Indian banking system. And everyone is involved – from top to bottom level employees of the branches.

Banks already have a huge readymade database of their clients’ personal details and financial situations. This data is used by branches to systematically mis-sell life insurance products and to unnecessarily churn mutual fund portfolios. Most importantly, this is done without truly recognizing the customer’s need or risk profile.

And frankly, this kind of misselling is hard to catch because products are sold through verbal sales pitches. Customers, trusting banks as the protector-of-their-interests buy into the sales pitch and then, you already know what happens – customers end up with a lot of unnecessary and unprofitable financial products in their personal portfolios which doesn’t help clients achieve their real financial goals.

Just a couple of days back, I read about how a well-known private bank’s relationship manager duped senior citizens for lacs of rupees.

My blood boiled after reading about it. Senior Citizens are very easy targets for mis-selling. And that is just one example of mis-selling. Just try searching for mis selling of insurance policies in India and mis selling by banks in India and you will find out other horror stories.

What do Indian Banks Mis-Sell?

There has to be a good reason for banks to do this. Isn’t it?

  1. Cross-selling products like insurances, ULIPs and mutual funds to existing bank customers help banks earn commission income. And banks want to maximize this commission income. So they just sell anything and everything as if there is no tomorrow.
  2. Bank employees are put under a lot of pressure due to the steep sales and incentive-linked targets for selling such third-party products. And they have to secure their jobs and hence, try to push these products down everyone’s throat.
  3. For all practical reasons, banks are unaccountable for doing this. There are RBI-issued checks and controls. But we all know how much such check & controls matter to the employees on the ground (who have sales targets to meet or else they will lose their jobs)
  4. Lack of adequate training and expertise of bank staff is often quoted as one of the major reasons. And this is true to an extent. Most relationship managers know s*** about what they are selling. But I don’t think that just giving proper training will help curb mis-selling. They will still do it if the sales targets are steep and incentivize them to do so.

It is common sense that the investment advice should be based on your financial goals. That’s goal-based financial advisory. But when banks are selling you something, it’s their own goals (commission maximization, sales target achievement, etc.) that they are trying to meet, not yours. 🙂

Data on How Banks mis-sell Mutual Funds

Mis selling of financial products by banks in India is very common. Till very recently, RBI was in a denial mode due to lack of proof. But things are changing and so is the regulator RBI’s stance on mis selling of financial products in India.

Banks have been selling insurance policies for years by acting as the Bancassurance channel for Insurance companies. Since banks reach is huge, this has no doubt increased the penetration of insurance in India.

In recent times, banks are doing the same with mutual funds. They are actively selling mutual funds to their existing customers. And you all know that MutualFundSahiHai 🙂 Here is a success story of mutual fund SIP.

Since I talk a lot about mutual funds and mutual fund SIPs, I thought I will share some data that will prove that how taking mutual fund advice from your banks is wrong.

Many mutual funds come from the same business house as the bank. There are several. And most of these bank-sponsored mutual funds are dependent on their sponsor for sales of their schemes.

Have a look at the below table which I have taken from Outlook Asia’s Manoj Nagpal’s tweet. It shows which AMC pays the largest share of commissions to each of the large MF distributors (in this case, banks):

Banks Mutual fund commission 2017

It is very clear that most banks, try and sell the schemes of their own fund houses.

Or lets put it this way – for each bank, the best mutual fund schemes to invest for their customers is none other than the schemes belonging to their own group! 🙂

That’s laughable!!

And there is a clear conflict of interest here!

Customers of the bank, unfortunately, don’t know this and tend to trust their bankers blindly.

The above table is based on data up to March 2017. Another detailed analysis (though of earlier years) can be found here and here. But the story remains the same.

Note – Please don’t think that here, I am trying to say that bank-backed AMCs are not good fund houses. I am not saying that.

But you really need to think about this – when you buy mutual funds through your bank, is the bank really advising you on what is right for you OR just acting as a seller who wants to get the maximum commission from whatever they can sell to you?

I think by now, you should know the answer.

What are the best mutual funds to invest in?

There are several ways to find this out. But one of the worst ways is to ask your bank or bank’s relationship manager. 🙂

And add the fact that banks only sell you the regular plans of mutual fund schemes and not the direct plans, it is quite evident that investing in mutual funds through banks is a bad choice.

Tip – If your bank tells you that you are their ‘preferred customer’ or ‘inner circle customer’ or gives you some similar classification, just run away! 🙂 A cross-selling bullet has your name written on it and will hit you soon. 😉

What should You do?

There is one thing that I should not miss saying here…

To be fair, it is not just about mis-selling of financial products by the Indian banks. It is also about mis-buying from the customers. It is their hard earned money and hence it’s their responsibility to find out what is right for them and what isn’t.

I agree that a subset of bank customers will still be unable to decipher what is good for their personal finances. But others need to wake up and acknowledge that the financial world is based on selfish interests of everyone. You need to look out for your own self.

As for the banks, they are still doing a fine job of providing ever-so-necessary banking services. But as of now, they are not suited for sale of other financial products. Due to their structure, they are geared to maximize sales and their commission income from financial products – and this leads to hard cross-selling of products which results in lots of mis-selling. Mis-selling by banks is very difficult to prevent unless radical structural changes are made.

So you should be wary of the advice you receive from your bank.

And banks may seem like doling out free advice in good faith. But free financial advice is very dangerous. And technically, it’s not even free. There is a commission hidden somewhere where you can’t see it.

For most people, banks are just good to do banking and nothing else. For real financial advice, you must understand that if it is good, then it won’t be free (just like legal and medical advice).

Before deciding the financial products you want to purchase, spend some time and find out your financial goals (download this free financial goal planning excel sheet), assess how much risk you can really take and then pick the correct financial products.

If you can’t do this on your own or need a second opinion, do not hesitate in seeking out investment advisors. Those advisors who are compensated only by you sit on the same side of the table as you and can work in line with your interests and help you make a solid financial plan.

Mis selling by banks in India is a reality. So now you know why you shouldn’t ask your Bank for Investment Advice or financial advice?

Google Search Double Money

Double your money & Rule of 72 – Save Yourself

I was recently talking to a friend and he casually asked me ‘How can I double my money?’

I asked him – ‘How much time do you have to double your money?’

He said that he would want it to happen as soon as possible. Maybe in a year if not earlier. 🙂

I was happy he didn’t say months or even days – as many investors aim for.

There is something remarkably attractive and glamorous about the concept of doubling your money. I am no psychologist but honestly, these 3 words ‘double your money’ – do give a high.

Try searching for doubling money on Google and it will gladly give you further suggestions (based on what people have already been searching for):

Google Search Double Money

Wow!

  • how to double money in one month
  • how to double money in a day
  • how to double money in 6 months
  • how to double money in 1 year
  • how to double money in bank
  • how to double your money in India in 30 days
  • how to double your money in a week
  • how to double my money today
  • 10 quick ways to double your money
  • 5 quick ways to double your money
  • and what not!

People indeed are in a real hurry to double their money! 🙂

But this post is not about how I can double money in a few years or months or even days. Rather it’s about sharing a simple rule to help you estimate how much time it takes to double your money.

And many of you already know it.

This is the Rule of 72.

And apart from telling money doubling time period or the rate at which investments need to grow to double, it can help you avoid being cheated! Yes. It can protect you from various people (agents selling various financial products) who can take you for a ride if you are not quick with basic maths.

So please pay attention.

Rule of 72

The following is a simple depiction of the rule, which can be used to answer your money doubling questions:

Time in Years x Annual Returns = 72

This might not seem logical to purists but this works in most simple cases.

And it can answer two questions that we all are interested in:

  • How long will it take to Double your Investment?
  • What is the required Rate of Return to Double your Investment?

So let’s see…

Q.1 – How long will it take to Double your Investment?

In order to calculate the number of years to double your investment, simply Divide 72 by the Rate of Return (or Interest).

No. of Years to double your Money = 72 / (Rate of Return or Interest)

For example, if you invest in a financial product that gives a fixed return of 8%, then your money will double in 9 years i.e. 72 divided by 8. So you now know that the popular debt instrument PPF (that gives around 8%), can double your money in 8 to 10 years (approx. as actual PPF rate changes frequently now).

Let’s take another example.

What if you are investing in an asset that gives you 15% returns? The answer to the ‘number of years required to double your money’ is 4.8 years.

But remember that this happens when returns are fixed at 15%. Equity can give an average 15% returns in the long run. But the equity returns are uneven and not in a straight line.

Here is how money doubles at different rates of returns:

Use this rule of 72 for answering basic questions of financial planning.

Ok done.

Suppose you estimate that for your new-born child’s marriage at age 24, you will need about Rs 40 lac (in future).

Now you have some surplus money that you want to keep aside for this goal. But you want to know whether this surplus money is enough or not.

So the rule of 72 can help you here.

Assuming you earn 9% assured return on your investment, you need 8 years to double your money (72/9 = 8). For the second doubling, you need another 8 years. And another 8 years for third doubling. In total, your money will double thrice in 24 years (8+8+8 years). Therefore, if you have an investible surplus of Rs 5 lac today (that can be invested at 9%), then you will get your Rs 40 lac in 24 years time without any new investment.

Current Surplus – Rs 5 lac

After 8 years – Rs 10 lac (Rs 5 lac doubles @ 9% in 8 years)

After 16 years – Rs 20 lac (Rs 10 lac doubles @ 9% in another 8 years)

After 24 years – Rs 40 lac (Rs 20 lac doubles @ 9% in another 8 years)

But if you don’t have Rs 5 lac to park away for 24 years or there are no assets to give you that kind of assured return, then you might have to invest more systematically for your financial goal.

So as you see, the Rule of 72 does give some basic idea here.

Now let’s take the next question

Q.2 – What is the Required Rate of Return to Double your Investment?

This question can be answered using the same rule differently.

Suppose you want to double your investment of Rs 5 lac in 5 years. What is the rate of return you need?

The answer is 14.4%, i.e. 72/5.

What if you wanted to double this Rs 5 lac in 10 years?

The answer is 7.2%, i.e. 72/10.

If you observe carefully, your required rate of return tells you one very important thing. And that is, where to invest?

If you need 14.4% returns, equity is the best option. For 7.2%, even the debt instruments will be sufficient.

Your required rate of return will help you identify the right asset class to invest in and the proper asset allocation that you should follow. You cannot expect 15% returns if you are investing in bank FDs. You only get returns that are in line with the average returns associated with the chosen asset class.

The attraction of doubling money can pull people towards various options which are not suitable for common savers and investors. Two common examples are currency trading (or currency derivatives trading) and cryptocurrencies.

The Indian Rupee has been sliding against the US dollar in recent times and many people have this perception that maybe, entering into currency trading might be a good way to generate some good returns.

But in spite of the potential to do very well in these markets (and I know a few people who have actually done it), the fact is that it’s not as easy as most people think it is. It requires effort and skill to learn currency trading in India before you can actually do it profitably. And please do not go blindly by the alluring forex trading advertisements that are plastered all over the internet. Remember that forex or derivative trading is not a get-rich-quick method as the online advertisements make it out to be. That doesn’t happen. It’s a skill and takes time to learn and profit from.

Another recent phenomenon (which has lost a lot of its charm now) was the easy-money perception of crypto-currencies.

Here again, the people believed that this is a way to get rich overnight and so hoards of investors started joining the party. But the crash that happened eventually has left most people with a bad taste for crypto-investments.

I know the magnetic attraction of doubling money can pull people towards ‘get rich quick’ schemes. But you need to protect yourself from making such mistakes.

How to use Rule of 72 to save yourself from being Fooled?

Doing calculations related to Rule of 72 are fairly simple. You can easily do it on your mobile phone’s calculator if not in the head.

So if some insurance or mutual fund agent tells you that he can help you double your money in 3 years, you can easily calculate that he is talking about 24% annual returns (=72/3).

This is not easy to achieve and you know it. He is fooling you. Just walk out from there. Remember this:

https://twitter.com/StableInvestor/status/885012265463894016

The rule of 72 can be used very effectively to avoid being cheated. It sends out a clear message to the person trying to fool you that you know enough maths to not be fooled. 🙂

So now you are armed with a small tool – the Rule of 72 – which will tell you in a matter of seconds, how long will it take to double your money. As for the question of how to Double Your Money, the answer is not as simple as this thumb rule of 72.

Note – The Rule of 72 is not 100% accurate and should be used with caution and only for rough estimates. It is at best an approximation tool. When doing calculations for your actual financial goals, you need to do more extensive and realistic calculations.

Remember that for most people, the way to wealth is typically on the slow lane. Keep your expenses down, invest wisely and regularly, have a long-term orientation and let compounding help you. You will surely see multiple doubling of your investments in years to come.

Difference between Financial Independence Vs Early Retirement Vs Financial Freedom

Financial Independence Early Retirement Financial Freedom

The words like Financial Independence, Early Retirement and Financial Freedom are slowly but surely finding a way into the thoughts and vocabulary of us Indians.

Their numbers are still very small but surely, there are people who are not just asking ‘How much is enough to retire in India?’ – Instead, they are asking ‘How much is enough to Retire Early in India?’

The interest is definitely there as I myself got some coverage in leading Indian newspapers for aiming for financial independence (here and here).

Regular retirement vs Early retirement – some people are considering the latter. 🙂 And to be honest, it’s not hard to understand the appeal of early retirement or financial independence. Just ask this question a little loudly – How much money is enough to never work again in India? It sounds nice and liberating. Isn’t it?

I regularly receive questions like these on mail from readers – How much money is enough to retire at 40 in India? How much money is enough to retire at 45 in India? How much money is enough to retire at 50 in India?

So the interest is really there. But I have already written a lot about this topic earlier in FIRE – Financial Independence and Retiring Early.

In this post, I wanted to address the difference between Financial Independence, Early Retirement and Financial freedom as I see it. People use these terms interchangeably. But there are some differences.

I must also tell you that there are no perfect definitions here. So you can interpret these words as you like – as long as it helps you achieve what you are aiming for.

Difference between Financial Independence Vs Early Retirement

Financial independence and Early Retirement are 2 different things, but which are linked to each other in a way.

So let me try to explain it simply.

Financial Independence means having enough assets (or/and income generating assets) that you do not have to work for money again. Now here is the important part – you may still decide to continue doing what you are doing even after achieving Financial Independence.

Early Retirement, on the other hand, means actually retiring (and doing almost no income-generating work) because you have achieved Financial Independence.

For obvious reasons, if you plan to retire early and never work again, then you will need a much larger corpus than if you were to be simply financially independent.

Together, both FI (Financial Independence) and Early Retirement (RE) are referred to as F.I.R.E. but remember that there is a subtle difference between financial independence and early retirement.

That brings me to another aspect of FIRE.

Different Types of FIRE (Financial Independence Early Retirement)

One of the main questions when it comes to FIRE is ‘How much do I need to retire early?

As you might have guessed, the answer is different for different people.

People’s lifestyles, their spending habits, financial situations, their real ability to take risks and several other factors influence their perception of how much might be enough for retirement. And therefore, the amount needed to achieve FIRE is different for everyone. But still, there are two major types of FIRE that people use as references:

  • LEAN Fire – This is a low-cost approach to FIRE. The idea is to reduce your expenses to the bare minimum (become ultra frugal) and achieve FIRE as soon as possible. It’s about having a life rich on time but short on luxuries. Lower the expenses, lower will be the FIRE corpus needed and sooner one can achieve it. That’s the logic here. For people targeting LEAN Fire, achieving the freedom at the earliest possible age is the most important factor.
  • FAT Fire – This is at the opposite end to LEAN Fire on the spectrum of FIRE. The goal is to retire early but not at the cost of quality. People who aim for FAT Fire also want to achieve it in a way so as to have enough for a better lifestyle. The corpus required for this is higher than LEAN Fire.

Both of these approaches are at the opposite ends. And it’s a matter of personal choice as to which one is better suited for whom.

In fact, there are no strict definitions. You can even label the levels in between as FIRE Level 1, FIRE Level 2, FIRE Level 3, etc. and take an aim at what you think is more suited for you.

And if you do an online search, you will find blogs for various levels – early retirement blogs, early retirement extreme blogs, frugal FIRE blog and what not.

So after having discussed Early Retirement and Financial Independence (both Lean and Fat FIREs), let’s tackle something related…

What is Financial Freedom?

I must warn again that there are no perfect definitions here. But I will try to say what I feel.

With Financial Independence (assuming something between LEAN and FAT), you are more or less locked into your chosen lifestyle. So if you chose LEAN FIRE and call it a day, then you really need to live frugally all your life because your corpus is smaller. On the other hand, if you chose FAT FIRE and took early retirement, then you can live a better lifestyle.

Now comes the difficult part to explain. 🙂

Financial Freedom I feel means that you live a much better life than what was possible in LEAN-Fire but also have the ‘real freedom’ to do few unplanned things (and spend on them) which you may not consider doing if you had a frugal lifestyle. In a way, it’s like having a FAT-Fire but with more flexibility.

Let me try with a mathematical example:

Suppose you are planning to achieve FIRE and have the following expenses:

  • Basic Expenses (Frugal Living) – Rs 40,000 per month
  • Discretionary Expenses (Better Living) – Rs 20,000 per month

Now if you are going for the LEAN-Fire, then you are mathematically allowed to spend Rs 40,000 a month. So that’s Rs 4.8 lac per year.

If you are going for FAT-Fire, then it allows you to live a life of Rs 60,000 per month kind of lifestyle (Rs 40K basic + Rs 20K discretionary expenses). That’s about Rs 7.2 lac per year.

Remember, having a FIRE corpus means that these kinds of expenses should be possible for you (with increasing inflation) for the rest of your life. And for early retirees, this means several decades!

Now comes Financial Freedom…

If I have the financial freedom, then mathematically, I should be comfortably able to spend annually:

  • Basic Expenses – Rs 40,000 x 12 months = Rs 4.8 lac, plus
  • Discretionary Expense – Rs 20,000 x 12 months = Rs 2.4 lac, plus
  • Another level of (optional) discretionary expenses = Rs 20,000 x 12 months = Rs 2.4 lac
  • Some unplanned luxuries (or unexpected expenses buffer) on an annual basis – Another lac or so

That’s real financial freedom! You can spend extra on few things here and there without having to spend sleepless nights thinking whether your corpus will run out before you run out of years or not. It also provides you with the buffer to spend in case of emergencies.

Achieving financial freedom also gives you the freedom from worry about money. And that’s the real freedom I guess.

So if I have to summarize, the timeline for corpus achievement goes like this:

LEAN F.I.   —>   FAT F.I.   —>   Financial Freedom

Early Retirement is up to the individual as to when he wishes to quit in between these levels. You can even look at these 3 levels as follows:

  • How much do I need to retire early?
  • How much do I need to retire early comfortably?
  • How much money do I need to retire early and never work again? 🙂

More Thoughts

I know a lot of people feel that FIRE is just about cutting your expenses and saving more. But that is not rightly completely. I would say that its also about simplifying and redesigning your life, which obviously gives you more time to focus on other things.

Aiming for FIRE helps you test your relationship with money. And it’s like asking yourself as to ‘What would you do if you didn’t have to work for money ever again?’ It also helps you decouple the idea of happiness from owning material things. It’s amazing when you actually realize it.

And one more thing. Achieving early retirement (and not just financial independence) not just requires cutting back on expenses. It also requires you to have a decent income from which you can save a lot.

If you are serious about achieving financial independence, then you should begin early. There are various thumb rules for financial independence and early retirement (FIRE). One such rule is that depending on when you wish to retire, you should have about 20-30x your annual expenses in your FIRE corpus. But let me tell you that thumb rules are good to begin with. Once you start your journey and are making progress, you need to ask more serious questions like:

  • How much money (Corpus) do I require for financial independence and early retirement (FIRE)?
  • How long will my corpus last?
  • How much can I draw from the corpus each year?
  • Can I draw more than what I answered in the above question, atleast in some years?
  • What will the inflation be in my retirement years?
  • What are my expected returns?
  • What will be the impact on your corpus if markets enter a bear phase just at the start?
  • What if I need to spend some money on unplanned and unexpected emergencies?
  • How will my other financial goals be tackled?
  • Have I saved enough for these other non-retirement financial goals?
  • And several other questions

Early retirement is an alluring goal or dream. No doubt about that. But to be brutally honest, very few aim for it. And even fewer can really achieve it. Most people are generally too late to begin with.

And apart from money, what does it take to retire early? …It takes a lot of focus and determination and a thick skin. And that’s because if you discuss these things with other people, you are sure to find many who will ridicule you. But if you are serious about it, then it means you will be going against the crowd and you will have to give a f*** to societal norms. If you don’t, then be ready for a regular retirement. That’s good and traditional too. 🙂 And there is ofcourse more to life than just money.

People feel that early retirement is a sort of hack to sort out their life! But I feel that retired life has too many other important aspects than just money. You really need to find out what you will do with all those years?? 🙂

If you are asking or searching for answers to questions like ‘How to plan for early retirement?’, then please beware of all the self-confessed best early retirement blogs, financial independence retire early blog, online resources, early retirement calculators, retirement corpus calculator India, financial independence number calculator, etc. Everyone has a different need and hence, the Financial Independence number and the Financial Freedom Plan will be different for everyone.

Time to end this article now.

In the debate of Financial Independence Vs. Regular Retirement, I would say that I prefer the FI. …But that’s my choice. If you feel that even the regular retirement is fine for you, then obviously that’s right for you and you should stick to regular retirement planning. You should never be forced to take a side because of the undue influence of others. Your life, your choice.

How to retire early at 40? How to retire early at 45? How to retire early at 50? What year can I retire? – Before you begin asking these questions, just stop and think for a moment as to is this really what you want? Or you are running away from something?

As for me, my aim is Financial Independence (and Financial Freedom). As for Early Retirement, I am too much in love with what I do (Investment Advisory and Goal-based Financial Planning) to currently think about retirement. 🙂 And that is the reason I focus on Financial Independence over Early Retirement.

But do not be disheartened if some of what I say seems too difficult to achieve. If you are willing to do what is necessary to achieve financial freedom, then let me tell you one thing – IT CAN BE DONE. I repeat. IT CAN BE DONE.

Dev Ashish Retire at 40

Featured in Mumbai Mirror (for How to Retire at 40)

My wife and I got some coverage in Mumbai Mirror a few days back.

The coverage was about people in India are working towards their Financial Independence (or Early Retirement) and trying to answer the question 🙂 How to Retire at 40?

Dev Ashish Retire at 40

Here is the article:

Dev Ashish Mumbai Mirror Early Retirement India

And here is the online link to the article.

Some time back, we got featured in Times of India about a similar topic of ‘Early Retirement in India’. Here is the link to that article.

Most readers know that financial independence is one of my major financial goals. I plan to do it by 40. Fingers crossed! 🙂 But let me clarify one thing here… as many people get it wrong.

Becoming financial independent or achieving early retirement doesn’t mean that I would not be doing anything after I turn 40. It only means that I would have accumulated enough money to take care of my expenses for the rest of my life.

I will without a doubt continue to do what I am doing right now – investment advisory.

Here once again, I must thank my wife Aditi who is my partner in crime in working towards this goal. Without her support, I could not have imagined aiming for such a goal. 🙂

If you are new to this idea of Financial Freedom or FIRE (Financial Independence & Retiring Early), then I have already written about it a few times:

Will try to write more about various aspects of Financial Freedom in near future – as I can clearly see that there are many people out there who wish to make Early Retirement as their biggest financial goal.

Thanks

Credit Cards – What you should Know and Do?

Credit Cards India Comprehensive Guide

Credit cards have their haters. I am not one of them.

In fact, they are quite useful if you know what to do with them. And to be fair, there is nothing right or wrong about using a credit card. It’s how you use them that decides whether you will have positive or negative or even catastrophic repercussions. 🙂

Now before you start searching for the best credit cards in India or begin comparing credit cards in India, more important is to understand what this animal is and how to tame it. You should first really understand how to use credit card smartly in India.

I have already written about why Credit Cards are Not Evil. I thought that I would write a little bit more about the topic.

Personally, I use credit cards myself. Don’t ask me for all the reasons. It’s very convenient and I always clear off the full dues before time. So I don’t pay any interest. So it works for me.

Now if you were to ask me about Debit Card vs Credit Card, I would prefer credit cards as I am a little apprehensive about the fact that debit cards are linked to our bank accounts and if somebody were to get access to our bank details via debit card, they may do some serious damage to us. 😉 Ofcourse there is no right answer to when to choose a debit card vs a credit card. It all boils down to your situation, preference and more importantly, whether you understand the pros and cons of both.

If you already are a credit card user, you will already know many of the things mentioned in this post.

But if you have questions like ‘how to use a credit card for the first time?’ in your mind, then I hope this post will be useful for you. So let’s move on.

Benefits of using Credit Cards India 

1 – Interest-Free Credit Period – This is the biggest benefit. If you don’t know how it works, then here is a small example. Suppose your billing date is 15th of the month. And your bill due date is 5th of next month – i.e. about 20 days after bill generation date. So now if you make a purchase of let’s say Rs 10,000 on 17th August, then this transaction will only get reflected in the bill generated on 15th September. Since the bill has to be paid by 5th October, you get about 49 days interest-free period between 17th August and 5th October. On the other hand, if you made the purchase instead on the 13th of September, then you will only get 22 days (13th Sept – 5th Oct). So all transactions do not get the full interest-free period of about 50 days. Depending on the transaction date with respect to billing date, the number of interest-free credit days will differ for each transaction. But nevertheless, this facility allows you to manage your finances and cash flows. This can be a useful facility for most people.

2 – Handling Emergency Situations – Most people can arrange money for emergencies (from savings, family, friends, etc.) in a couple of days. But what if the need is more urgent? Credit cards are useful in such cases. More so if you know that you do not have enough savings. A credit card allows you to take the money and use in emergencies and then figure out how to repay it later. And that is what is needed in emergencies.

3 – Reward Points & Cashbacks – I am not a big fan of these as these can psychologically force people to spend money unnecessarily. But it is still an added advantage. I generally use reward points to buy books via ecommerce sites. So good for me. 🙂

4 – Discounts – These again entice people to spend more money. But if you only stick to buying what you need, then discounts are a good thing to have. Isn’t it? Who doesn’t want them?

5 – Possibility of Interest-Free EMI – Many cards have tie-ups with various sellers and at times, allow you to convert your purchases into interest-free EMIs (at times with and at times without processing charges). This is helpful for people who want to spread large expenses over a period of a few months to reduce the burden on their monthly budgets.

6 – Credit Card usage helps build CIBIL Score – If you maintain a decent credit limit and % utilization of the credit limit, then slowly it will help you increase your credit score. But do not go for too many cards as this will seem like a credit-hungry behaviour to the rating agencies.

7 – Then there is the factor of operational efficiency that comes with credit cards. This factor in itself clinches the game for me.

Before you accuse me of painting too rosy a picture of credit cards, please understand that credit cards by themselves are neither good nor bad. If you use it irresponsibility, you will end up damaging your personal finances and future financial health. Having the discipline, using it only when you can pay it back fully, staying within reasonable % of credit limit, etc. is how this tool should be used.

But if you cannot do these, then the credit card is not for you. You should not have them. And you should not read the rest of this post. 🙂

Now if you are still with me, let’s move on…

How does Credit Card charge interest?

If you do not understand the mathematics of credit cards, you will not use it well. And if you don’t use it well, you will become a victim of mounting credit card debt. And that can be disastrous.

I will try to explain the maths of how credit cards calculate interest and how it works in as simple an example as possible.

But before we proceed, do remember and acknowledge this fact that the interest rate on credit cards is highest among all forms of credit facilities that are available to us. It can be as high as 40% annually or 3.5% monthly. Just read those interest rates again. For comparison, let me remind that a fixed deposit gives 6-7%, savings account 4-6% and equity gives about 12-15%. And with credit cards, you are paying 35-40%.

So with that understood, let’s understand a few terms that you should be aware of when using credit cards:

‘Interest-free period’ is the difference between the date of the transaction and due date of payment for that billing cycle. This period is obviously different for each transaction and during this period, you don’t have to pay any interest on your transaction – provided you pay the entire bill outstanding by the due date.

‘Minimum Amount Due’ (MAD) is the minimum amount that has to be paid by the due date. Paying atleast MAD will ensure that you don’t pay any late payment fee and your credit card account will not be reported as irregular which can have an adverse impact on your credit score. But remember… by paying just the MAD, you will still not avoid interest on the unpaid amount (Full Due Amount minus MAD).

Let’s take a scenario now.

Assume the following:

  • Credit Card Bill is generated on 15th of every month
  • Payment Due date is 6th of every month
  • Interest charged is 3% per month

Here are the transactions:

Scenario 1: When Full Dues Cleared before Due Date

  • 9-Aug – Purchase (Rs 20,000)
  • 15-Aug – Bill generated (Outstanding-Rs 20,000; Minimum Amount Due-Rs 1000; Due Date-6th Sep)
  • 3-Sep – Payment (Rs 20,000)
  • 15-Sep – Bill generated (Outstanding-NIL; Minimum Amount Due-NIL; Due Date-6th Oct)

Scenario 2: When Full Dues Not Cleared before Due Date

  • 9-Aug – Purchase (Rs 20,000)
  • 15-Aug – Bill generated(Outstanding-Rs 20,000; Minimum Amount Due-Rs 1000; Due Date-6th Sep)
  • 3-Sep – Payment (Rs 1000) (Paid only Minimum Amount Due)

Now the statement that will be generated on 15-Sept, will have the following components:

  • Outstanding Amount = Rs 19,000 (Rs 20,000 – Rs 1000)
  • Interest@3%p.m. on Rs 20,000 from 9-Aug to 2-Sep = Rs XXX
  • Interest@3%p.m. on Rs 19,000 from 3-Sep to 15-Sep = Rs YYY

So the bill generated on 15-Sep will be of Rs 19,000 + XXX + YYY.

And that’s how to calculate Credit Card Interest. You can even find credit card interest rate calculators online.

And had you not paid the minimum amount due (MAD) of Rs 1000 before the due date (of 6-Sep), you would also have to pay an additional late fee.

As you can see, if you make regular and full payment to your credit card account, you can get interest-free credit. However, if you don’t make the full payment and/or pay only the Minimum Amount Due, you will not get any interest free credit period. Also, you will be charged a lot of interest till you clear it off. So if you are planning to just Keep Paying the Minimum Amount Due on credit card every month, then let me tell you that it’s a very bad decision. You will bear a lot of interest cost over the period in which you will be clearing the full outstanding. And if in between you keep making purchases, then those too will be added to overall outstanding and will be charged interest accordingly. This can easily spiral off into a debt disaster.

These are the very reasons why you should pay off your credit cards dues in full. Now you know the right answer to the stupid question ‘is it better to pay off the credit card or keep a balance?’ 🙂

So to repeat – it’s in your best interest to try and make credit card payments in full every month.

If for some temporary reasons you are unable to clear the full dues, make sure that you pay atleast the Minimum Amount Due. However, don’t make this your default option and clear off the full due as soon as possible.

So now you more or less know how to calculate interest on credit cards. I would suggest that you go through the ‘Most Important Terms & Conditions’ or MITC of your credit card. The MITC of your credit card clearly explains the methodology used to calculate interest with examples and have a lot of other important details.

Some Tips & How to pay off your Credit Card Debt?

You have your credit card. Few people already know the best ways to use credit card in India. 🙂

The basic principles are universal. But if you have doubts, then the questions you should be asking is to how best to utilize it without making the common mistakes that credit card users make.

Let me try and list down some tips or let’s say, best practices:

  1. Always pay the credit card dues on time and before the statement due date.
  2. Do everything possible to pay the full amount, on time and every time. If for some reason, you can’t do it occasionally, its fine. But if this becomes a regular thing, that means you are spending more than what you can afford. Stop using your credit card immediately.
  3. This is linked to the above point. Try to pay in full. But if not, make sure you atleast pay the Minimum Amount Due.
  4. Do not use the full credit limit of your card every time. Every rupee you use, it is you and you alone who has to repay back. Some estimates say that using about 30% of your credit limit is considered to be healthy.
  5. Credit cards offer attractive reward points and cashbacks. But that doesn’t mean you should use the card unnecessarily just to score some cashbacks or earn reward points.
  6. To start with, just keep 1 credit card. That is sufficient for most people. But if you really have the need for another, then question yourself whether you are spending more than what you should be? Or if you want to have more cards due to your spending patterns and as many spend-specific cards can be actually beneficial, then do not go beyond 2-3 cards.
  7. If you have two cards, try to keep the statement dates around 15 days apart. So, for example, Card#1 has a statement date of 15th of the month and Card#2 has a statement date of 1st of the month. Then if you want to optimize your spendings and make full use of the interest-free period, you should use the Card#1 for spending between the 1st and 15th of the month and use Card#2 for spending between 15th and 31st of the month.
  8. If you unfortunately and somehow run up a huge credit card outstanding balance, then first of all, stop using the card. Next, liquidate some savings or borrow money from family, friends to clear the mess. Credit card interest rates are 30-40%. So you should get the mess cleaned before it becomes a personal finance disaster. You can even consider taking a personal loan which will be much cheaper than credit card debt.
  9. If you are about to take a card, do pay attention to the joining and renewal fees. Some credit cards offer zero joining and renewal fees. But when looking for a credit card, pay attention to the fee structure alongwith the card’s benefits. Moreover, many cards allow a fee reversal if you spend a certain amount annually. Look out for these benefits and be prudent about it. Do not go after benefits which are not useful to you.
  10. Some people are credit card reward point’s monsters! 🙂 They know how to take out the maximum benefit from their cards. Maybe you and I cannot be like them. But still, take time to understand the rewards structure. Maybe, it might work for you well.
  11. Do check and verify your credit card statements every month. Scrutinize each item carefully to be sure that you are not been taken for a ride knowingly or unknowingly.
  12. If you feel that a high credit limit is the reason you are unable to lower your card spends, then first of all, you are to be blamed. Go ahead and get your limit lowered. But remember, lowering of credit card limit may not be the solution. If your credit limit is reduced, your % utilization of the credit card will increase. And it will have a negative impact on your credit score. So better to control yourself.
  13. Do not withdraw cash from ATM using credit cards. There is no interest-free credit period if you use your credit card to withdraw cash. You have to pay interest from the very first day and remember, the rates are exorbitantly high.
  14. If you want to get a credit card but can’t get it, you can consider applying for Credit Cards against Fixed Deposits. This will help you build credit history and a decent credit score – which will be needed for future (bigger) loan applications when you apply for home loans, etc.

Since we have discussed enough best practices, let’s tackle just one major question – which many people having unmanageable levels of credit card debt would be asking.

Should you take a Personal Loan to pay your Credit Card Dues?

The mere fact that someone is asking this question means that they are in trouble.

If it is you, then first of all, you spent more than you could afford. You spent more than what you could repay immediately. You spent more than what you could repay after some time. You either don’t have savings to dip into or you don’t want to liquidate them. You may have also tried borrowing money from friends and relatives without success.

So you are here now.

A lot of credit card debt which you find it extremely difficult to service every month.

The realization might have now been there that handling credit card is not as easy as it seems and it is way too easy to overspend when using your credit card.

But there is a solution. It’s not perfect. But nevertheless a better one. And that solution is to take a small personal loan. It will act as a credit card debt consolidation loan – which will help you overcome your credit card dues at one go.

There is an obvious advantage of this strategy – A personal loan is way cheaper than the credit card interest rates. You can get personal loans at around 15-20% whereas credit card costs around 30-40%. And before you take a personal loan, you can check out personal loan EMI calculators that are easily available online.

Since you would have cleared your high-interest loan at one go, this will have a positive impact on your credit score. But beware – you still need to service the personal loan EMIs and if you fail to do so on schedule, you will once again receive negative vibes in your credit score.

Now those opting for this strategy must not forget that in spite of comparative cheapness of personal loan (when compared to Credit Card), the fact is that personal loans themselves are very costly loans. So this should be your last move after you have tried our all other options like reducing your expenses to pay more, liquidating some short-term savings, borrowing from your people, etc. And why you should aim to be loan-free? You already know how relieved you feel when that happens. Isn’t it? 🙂

Finally…

Credit cards are useful no doubt. But if you can’t manage its power well, then you should not keep it with you. They say with great power come greater responsibilities. 😉

I don’t have anything else to say after what I have already written.

Just be careful when using your credit cards, be sensible about your spendings and try to understand how credit card and credit card interest calculations work. Once you know it, you yourself will become extra careful about how to use credit cards and in fact, how to use credit cards smartly and wisely.

So is it good to have credit cards?

I have already written a few thousand words in this article and an earlier one. So I have nothing to add now. 🙂

How much Housing Loan should you take?

How much Housing Loan should you take_

Most people need a housing loan to purchase their first house. And I know what you might be thinking when you saw the title of the post ‘how much home loan should you take’.

As much as possible or as much as I can afford. Isn’t it?

But before we talk about in detail as to how much home loan should you take, let’s give some thought to the on-going but growing debate between buying vs renting a house.

I will try not to take sides but it is difficult.

A house in spite of being the biggest expense of most people’s lives is also an emotional decision. And no number can be attached to this emotion. No matter what the online buy vs rent calculators might be telling, I believe that most people would want to buy a house eventually. That’s what makes us human. 🙂 Ofcourse there will be some who feel that staying on rent forever is the way to go. But such people are still in a minority.

Now I am not a very big fan of real estate as an investment. I prefer equity. But I also feel that having one house somewhere is a good idea. Whether you decide to buy a house early in your career or later is a personal decision. Since I mentioned the word ‘investment’, here is a detailed analysis of investing in Equity Mutual Funds vs investing in Real Estate. You might find it interesting. You can also have a look at this Real-Life case study of MF vs Real Estate investing in India.

So let’s come back to the agenda for this post

How Much Housing Loan Can You Take?

This is not an easy question for most people but it also has a mathematical approach to help you decide.

Let’s look at it from the lender’s perspective. What does a bank/organization giving home loan wants to know?

  • Do you earn enough to be able to service the home loan EMIs?
  • Will you continue to earn enough to repay the home loan fully in future?
  • How has your past loan repayment behaviour been? Did you miss paying EMIs occasionally or regularly?
  • Do you have other loans (like a car loan, personal loan, education loan, etc.) where you are already servicing the EMIs?
  • Do you have some other financial assets as well?
  • Can you bring in some money (about 20% downpayment) from your own pocket to make the house purchase?

These are some of the major factors that lenders consider among many others.

Now generally, lenders have this rule that says that you should only be using about 30-40% of your income for loan repayments. Let us assume 40% for simplicity.

So if you earn Rs 1 lac per month, lenders will give you a loan that has a maximum EMI of about Rs 40,000 (i.e. 40% of Rs 1 lac).

If now you do some reverse calculations, you will know what home loan amounts are available for the EMI of Rs 40,000 per month. Ofcourse the loan amounts will vary for different combinations of loan tenures and interest rates.

So from the lenders perspective, we have answered the question – What percentage of monthly income should my home loan EMI be?

But let’s be practical, I am pretty sure that most people would be willing to stretch this ‘40% of monthly income as EMI’ to even ‘50% or even more of monthly income as EMI’ if the right property comes along. Isn’t it?

But should you do this?

Because this will obviously impact your ability to manage your personal finances, savings for other financial goals and your lifestyle. And everybody has a different expense pattern so it is difficult to say anything in general. So some people will find it comfortable even if they have to pay more than 50% of their income as EMI. Others will find it difficult to pay even 30% of their income as EMI due to higher expenses.

Also, what if you are taking a loan with your spouse and eventually the plan is for your spouse to quit working? Will you still be able to foot the entire EMI bill from single income?

Some feel that renting for some more years is better than choosing a small house just to keep your loan EMIs down. Then there are others who feel that it’s better to buy a house (even if small) soon and then, later on, when income is higher, they can buy a bigger house by selling the first one.

Both seem to be practical approaches. To be honest, it’s difficult to judge anyone here.

Buying a house as soon as possible gives you the satisfaction of having arrived in life. You own a house dammit! 🙂 You are also protected from the future increase in property prices as you have already made your purchase. You can then use fresh enthusiasm and free surplus income to pursue other financial goals (free excel download).

Buying a house later when you are more settled and have a higher income is also one common approach. Since income is high, you can even go for a bigger and better house (assuming you need it) as you can service a bigger loan and EMIs as your EMI/Income Ratio (40% max) has a bigger denominator.

As I said earlier, both approaches are right for different types of people. It’s a personal choice.

You already know that your credit history plays a major role in the lenders deciding whether to lend to you or not. Your cibil report tells the lender how you have been repaying your past loans. Have you been a good borrower who repays each EMI on time? Or you have been a not-so-good borrower who misses his EMI every now and then and finds it difficult to close his loans cleanly.

And did you know that in some cases, your score also decides what loan interest rate will be offered to you? If your score is high, you might get the loan at a lower rate! And that can save you tons of money in the long run. So it would be a good idea to check your credit score before you apply for a home loan. Atleast you will know whether the score is good or bad and accordingly, you can negotiate with your lender for better loan rates.

Some More Thoughts

Real estate juggernaut went on for more than a decade till it eventually slowed down in last few years. Earlier, people used to keep taking loans to buy houses and sold them a few years down the line because prices were rising enough to prepay the home loan and still make a huge profit. And this was being repeated. An entire ecosystem got built around people’s interest in this asset as an investment (Read more about the reality of Indian real estate).

But people still need houses and will buy them. If not as an investment (thankfully) then as something for personal use. I offer some thoughts here about making the house purchase:

  • Buying one house is enough for you. And unless you are really getting a good deal in properties, there are other reasonably good investment options to consider.
  • If you want to buy a house in the early part of your life, then so be it. But still don’t be in a hurry. It’s a big decision. Take your time to decide it correctly.
  • Banks and other lenders want you to take a huge loan so that they can earn interest on higher loan amounts. But it’s in your best interest to not stretch yourself too much. They say 40% of your income can be used for EMI payment. But if you can bring in higher downpayment (i.e. take a smaller home loan), then it is not a bad idea to have a lower EMI component.
  • It’s a good idea to wait for a few years and save up a sufficiently large amount (preferably larger than 20% of house cost) as the downpayment. Depending on your saving capability, eagerness to buy, available time (years) at hand and market conditions, you can even consider having some equity component in your savings for this downpayment.
  • Understand this concept fully – shorter the loan duration, lower will be the interest component, but higher will be loan EMIs.
  • Depending on how much home loan EMI you can comfortably service with your current income, keep the loan tenure as about 15 or 20 years.
  • Do make up your mind that you will clear this loan earlier than the originally stipulated tenure. But making mind is not enough. You will have to do something about it too.
  • One way is to try and pay one extra EMI every year (atleast).
  • Another way is to use your annual bonuses to prepay part of the loan.
  • Then there is a case for going for a longer than usual loan tenure of let’s say 30 years. Why and when? This approach uses a combination of home loan EMI and mutual fund SIP. A longer tenure means lower EMIs. The savings made on lower EMIs can then be invested every month in something like equity mutual funds SIP– which is expected to do well over long periods. Assuming equity does deliver decent returns, this approach of selecting a longer loan tenure and doing the SIP can help you repay your loan earlier. This approach might suit some people but is not for everyone. I will write about this approach in detail sometime later.
  • There are many who want to do keep it simple and be done with their loans as soon as possible (and live a loan free life) without any financial jugglery. They will aggressively repay their home loans. But if done too aggressively, this approach can compromise savings for other financial goals. And that is not advisable – more so because home loan rates are fairly low if you consider tax breaks on offer.
  • Ensure that you have an adequate life insurance that can be used to pay off the loan if you were to die tomorrow.

Loan Free Life – Possible and Worth the Effort!

Loan debt Free Life

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:

Loan EMI Monthly Obligations

* 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:

Monthly Cashflows Personal Income

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?

See?

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.