Debt is not a monster as many people believe it to be. In fact, it can be considered good for your finances if it’s helping you build wealth. For example, taking a loan to buy a house with a sound financial plan could be a good debt as it will be an asset value and would help you build wealth in the long term. However, other kinds of debt, such as high-interest credit card debt, excessive borrowing, and unmet EMI dues are not so healthy for your finances. “Two thumb rules serve as a financial indicator of a debt trap: First is EMI exceeding 50 per cent of income and the other being fixed expenses (i.e., obligations towards rent, maintenance expenses, fees towards education, etc. as well as EMIs) being more than 70 per cent of income,” says S Ravi former chairman of BSE and Founder, Ravi Rajan & Co.
He further notes that one has to follow appropriate finance and resource management starting from budgeting, paying dues on time, allocating certain portions for saving and insurance, and future planning in order to be efficient and effective in debt management.
Take Stock: “It’s important to sit down and analyse your finances with a microscope,” highlights Naresh Bulchandani, CFA (Merisis Wealth).
First and foremost, one should begin by getting a stock of the situation. Understand your fixed commitments, discretionary spending, what EMIs you currently have running and what are the actual interest costs being charged to you on every single loan outstanding. “More importantly, include making investments as a part of your regular fixed commitments,” Bulchandani notes.
Split Mandatory v/s Discretionary Spends: One of the most effective strategies for managing and reducing debt is to first identify your spending pattern. “One should categorise their spend into mandatory and discretionary,” Abhishek Kumar, CFA (SahajMoney) suggests.
After this, try to reduce your discretionary spending to increase your monthly surplus. This surplus can be used to pay off high-interest loans such as credit cards or personal loans. “Also, windfall income through annual bonuses should be used to prepay these loans at the earliest,” Kumar suggests.
“Stop having that customary coffee from Starbucks for a while. Cutting chai at a local chai tapri would do just fine for your caffeine cravings,” Bulchandani says on a light note.
Debt Avalance Strategy: The strategies that can be put to use for being effective are prioritising loan repayments with high interest rates as they cost more over time. “Replace/repay your highest-cost debt first such as over-due credit card outstanding or other high-cost personal loans and then move on to repaying other outstanding loans,” Bulchandani says.
Build an Emergency Fund: It is important to build an emergency fund that can take care of your fixed expenses for at least 6 months.
“Everything looks easy when forecasting on an Excel sheet but then life happens. You could lose your job, get sick, or have an accident – all of which could affect your earning capability in the short term which will put an added burden on your finances,” Bulchandani says emphasising the significance of creating an emergency fund.
Good Debts and Other Means: ‘Stay in debts that provide tax benefits such as home loans and education loans,’ S Ravi suggests. Other than this, he says, ensure payment towards the minimum due on credit cards to avoid late fees or penal interest rates, take appropriate insurance covers, and carry a cost-benefit analysis of investing in fixed deposits vs repaying loans.
