Debt cut strategies useful for borrowers but they come at a cost

Loan restructuring and moratorium increase interest outgo

Households in India are under higher stress currently, with household debt-to-gross domestic product ratio rising from 32.5 per cent in 2019-20 to 37.3 per cent in 2020-21, according to a report by State Bank of India. Households should consider deploying one of the debt-management strategies outlined below to extricate themselves from their predicament.  

Consolidate your debts

Here, the borrower takes his multiple, usually high-cost loans and converts them into a single, lower-cost loan. Expensive, unsecured loans and card outstanding are usually converted into a single, collateral-backed loan.

Says V Swaminathan, CEO, Andromeda & ApnaPaisa: “The cost of your debt declines. A single loan is easier to manage. However, you will have to produce some collateral.”

Such loans, however, come with certain pre-conditions.

Says Adhil Shetty, CEO, BankBazaar: “Debt-consolidation loans usually come with a debt agreement which stipulates that the loan amount can be used only to repay existing loans and the loans would be closed within a fixed period, without delays. A restriction could be imposed on borrowing further during the consolidation period.” 

Restructure your loan

Here, the borrower renegotiates the terms and conditions related to his loan with the lender.

Says Manish P Hingar, founder, Fintoo: “If you are not able to pay off your existing loan, you can get it restructured with your bank. This can involve lowering the equated monthly instalment (EMI) and extending the tenure.”

An extension of tenure, however, leads to higher interest cost for the borrower.

Suppose a person has a loan of Rs 50 lakh that has to be paid in 10 years. His EMI is Rs 59,351. Under these conditions, he will pay a total interest cost of Rs 21.2 lakh. To ease his burden, he gets the tenure extended to 15 years. His EMI comes down to Rs 46,351. However, the total interest cost he has to pay will rise to Rs 33.4 lakh — an increase of Rs 12.2 lakh.   

According to Gaurav Aggarwal, senior director, PaisaBazaar, “Debt restructuring affects the borrower’s credit score negatively, and hence, his eligibility for taking loans and credit cards in the future.” 

Borrowers can avail of the Reserve Bank of India (RBI)-mandated second restructuring facility until September 30.

Seek a moratorium

Here, the borrower does not need to make any repayment for a specific period. Says Shetty: “This can be in the form of moratorium offered by the RBI last year due to extenuating circumstances, or it could be built into the product itself, as in the case of education loans.”

In the latter case, the length and terms and conditions related to the deferment period are built into the loan agreement.

While such a deferment gives one breathing space, it comes at a cost. Usually, a simple interest is charged on the principal for the period before repayments begin. So, the amount you repay eventually is larger.

Says Hingar: “Only borrowers who are unable to pay the EMI because of temporary job loss amid the pandemic should opt for debt deferment.” 

In case of an education loan, borrowers are allowed to start repaying EMIs after one year of completing their course or six months of getting a job, whichever is earlier.

Says Aggarwal: “Simple interest will keep accumulating on the education loan during the moratorium period. Lenders offer interest rate concession of up to 1 per cent to those who service the interest cost during this period.” Hence, do try to service the interest component during the moratorium if possible.

Loan deferment does not affect a borrower’s credit score.

Says Swaminathan: “But such deferments could be noted in the credit report and could affect future lending decisions.”