Tuesday 24 November 2015

Rules to follow when taking a loan


Don't borrow more than you can repay

The first rule of smart borrowing is what the older generation has been telling us all the time: don't live beyond your means. Take a loan that you can easily repay. One thumb rule says that car EMIs should not exceed 15% while personal loan EMIs should not account for more than 10% of the net monthly income. Your monthly outgo towards all your loans put together should not be more than 50% of your monthly income. If your EMIs gobble up too much of your income, other critical financial goals, like saving for retirement or your kids' education, might get impacted. Retirement planning is often the first to be sacrificed in such situations.

Keep tenure as short as possible

The maximum home loan tenure offered by all major lenders is 30 years. The longer the tenure, the lower is the EMI, which makes it very tempting to go for a 25-30 year loan. However, it is best to take a loan for the shortest tenure you can afford. In a long-term loan, the interest outgo is too high. In a 10-year loan, the interest paid is 57% of the borrowed amount. This shoots up to 128% if the tenure is 20 years. The longer the tenure, the higher is the compound interest that the bank earns from you. Increasing the EMI amount can have a dramatic impact on the loan tenure. Assuming that the borrower's income will raise 8-10% every year, increasing the EMI in the same proportion should not be very difficult.

 Ensure timely and regular repayment

Missing an EMI or delaying a payment are among the key factors that can impact your credit profile and hinder your chances of taking a loan for other needs later in life. Never miss a loan EMI, even if it means missing other investments for the time. In an emergency, prioritize your dues. You must take care never to miss your credit card payments because you will not only be slapped with a non-payment penalty but also be charged a hefty interest on the unpaid amount. If you don't have the money to pay the entire credit card bill, pay the minimum 5% and roll over the balance. But don't make a habit of this because at an interest rate of 24-36%, credit card debt is the costliest loan you will ever take. To avoid missing the due date every month, just give standing instructions to your bank to pay the minimum 5% amount whenever the bill is due.
Don't borrow to splurge or invest
This is also one of the basic rules of investing. Never use borrowed money to invest. Ultra-safe investments like fixed deposits and bonds won't be able to match the rate of interest you pay on the loan. And investments that offer higher returns, such as equities, are too volatile. If the markets decline, you will not only suffer losses but will be strapped with an EMI as well. Avoid taking a loan for discretionary spending. You may be getting SMSs from your credit card company for a travel loan, but such wants are better fulfilled by saving up. It's not a good idea to take a personal loan for buying luxury watches and high-end bags.
Take insurance with big-ticket loans
If you take a large home or car loan, it is best to take insurance cover as well. Buy a term plan of the same amount to ensure that your family is not saddled with unaffordable debt if something happens to you. The lender will take over the asset (house or car) if your dependents are unable to pay the EMI. A term insurance plan of Rs 50 lakh will not cost you too much. Typically, banks push a reducing cover term plan that offers insurance equal to the outstanding amount. However, a regular term plan is a better way to cover this liability. It can continue even after the loan is repaid or if you switch to another lender. Moreover, insurance policies that are linked to a loan are often single premium plans. These are not as cost effective as regular payment plans.



About Author: The author of this blog has a passion for writing and has written many blogs related to bpo, business solutions, customer service, outsourcing.


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