Don't fund lifestyle needs with debt; limit your total EMI outgo

Limit the sum total of all your EMIs to 50 per cent of take-home salary

Twenty seven-year-old Yash Srivastava, an IT professional with a passion for photography, took a loan of Rs 1 lakh from a non-banking financial company (NBFC) at 15 per cent interest to fund the purchase of a high-end DSLR camera and accessories. Since his salary was only Rs 30,000 then, he found himself in a financial tight spot for months thereafter. Srivastava regrets his rather impulsive decision to fund, what was essentially a lifestyle expense, with a high-cost loan.  

Buy now, pay later culture 

Many millennials appear to have made “Spend more and bring home happiness” their life’s mantra. Online sales, announced at regular intervals, come with new products and new offers. They whet the shopaholic’s urge to purchase more, even if funds are drying up. Moreover, a loan is always available to sew the deal. Often, these personal or consumer durable loans carry high interest cost. “Many expenditures stem out of lifestyle-related aspirations. Desires range from buying footwear online, going on a weekend trip, to buying a high-end mobile phone, among others,” says Gaurav Jalan, founder and CEO, mPokket, a digital lending platform that offers short-term personal loans to college students.

High cost of debt

But loans can take a heavy toll on a person’s finances. Take an example. Suppose that an individual buys a gadget costing Rs 80,000 with a two-year loan at 16 per cent interest. The EMI is Rs 3,917. The extra interest the person pays over the loan tenure is Rs 14,009. Thus, he pays almost 18 per cent extra. Processing fees, ranging from 1-3 per cent, add further to his burden. Not many people account for this extra monetary outgo. 

Banks are often not too keen to lend money to youngsters who end up borrowing from NBFCs and online fintech platforms at higher rates. “Today, availing a personal loan has become easy due to technology. The interest rate is made to look attractive by being stated as a monthly charge, like 1-1.5 per cent per month. It is easy to be entrapped by such debt. Sellers offer interest-free EMIs when they conduct a sale, which lure many buyers,” says Anil Rego, founder and CEO, Right Horizons.

Urge to upgrade

The desire to upgrade makes matters worse for the inveterate shopper. The mobile phone needs to be upgraded every two years; the laptop, every three years; and the car, every five years. Each new purchase at periodic intervals funded by a loan makes it difficult to save and invest.

Frequent spending pushes up the credit card bill and makes many opt for EMI options. Too many such loans push the borrower into a debt trap. “While there is nothing wrong with wanting to splurge and borrowing money to do so, the frequency of such expenditures should be limited to avoid creating financial liabilities that become difficult to manage,” says Jalan. Here are a few simple tricks that can help you avert piling up debt:

Make a shopping list: This may sound like routine advice but is effective. Once you have made your list, avoid buying anything that is not on it. Preparing a shopping list forces you to buy only what you need. All those ‘deals’ that come your way on shopping portals or malls get automatically eliminated if you follow this approach.

Restrict payment options: Keep only one or two credit cards with low limits on your person. Carry minimum cash with you. You may even do away with credit cards altogether and use debit cards only. That way you will only spend what you have.

Automate savings and investments: Make saving and investment a priority. The bank with the salary account could be instructed to transfer at the start of the month some money into another account, or into an investment such as bank recurring deposits or systematic investment plans of mutual funds. Such automatic transfers will ensure that a lower disposable income is available optically. “Ideally, one should first save between 20-40 per cent of the take-home salary, invest it, and then with the balance amount prepare a budget for recurring and one-time expenses, and stick to it for the rest of the month. Spending on gadgets and automobiles needs to be thought through carefully before the money is spent,” says Rego.

Limit your total EMI outgo: Main­taining a ceiling on the sum total of your EMIs will also help you stay solvent. “The basic rule of thumb to follow is that all your EMIs together should not exceed 50 per cent of your net take-home salary,” says Arun Ramamurthy, co-founder, Credit Sudhaar, which helps customers repair their credit profiles. Nowadays, many lenders are willing to lend up to 60 per cent of take-home salary, based on the expectation that the person will receive an increment next year. Say no to all such offers.  

Refinance high-cost loans: Due to easy availability, many borrowers sign up for personal loans that are unsecured in nature and hence carry relatively higher rates of interest than secured loans. When repaying, list all your loans in descending order of interest cost. Try to refinance higher-cost loans with loans taken against assets, such as gold, shares, bonds, home (top-up) and loan against property, all of which carry lower rates. This will reduce the loan burden. Since many of these are longer-tenure loans, the EMI will also come down. The money freed up can be invested to meet financial goals.