“Never spend your money before you have it” – Thomas Jefferson
“The man who never has money enough to pay his debts has too much of something else” – James Lendall Basford
These are little quotes on debt for you to think about.
Table of Contents
- Why do you even take Loans?
- How does a Debt start
- EMI (Equated Monthly Installment)
- Prepayment of loans
- How prepayment helps you?
- Do loans help in Tax Saving?
- How to pay off your debt faster?
- Reduce your interest burden
- Should you Invest or Pay off debt?
Now let’s see what Debt Repayment is.
Debt repayment is a process of paying off your principal debt balance on a loan over a period. Knowing how to use debt wisely and repaying your debt effectively is a good sign of money management. It includes understanding the terms in the Debt Repayment process.
Repaying debt efficiently will stop you from handing over more interest. It also saves you from a penalty fee, that is paid if you miss an EMI payment, which in turn can hurt your credit score.
Why do you even take Loans?
Commonly used loans are home loans, car loans, and education loans. Repaying the loan is a very big commitment. It’s a promise to pay an amount each month to the bank.
The burden of debt is always on your mind. You keep worrying especially when layoffs happen or
when you continuously suffer from ill-health. You are more worried about the after-effects of job loss than the job loss itself. The pressure of paying back debt is huge. You may not like your job but would stay as you have to pay back a huge debt.
How does a Debt start?
Let’s find how a debt starts. Some are due to your needs, some due to your desires and some due to family and societal pressure. A car or bike loan can be a need for some and a desire for some. A vacation on EMI is a desire. A home loan can be due to family pressure even if a person is not ready for such a commitment. A personal loan for a wedding or a function can also lead to debt.
At times, it can be a casual attitude towards debt and entertaining too much for instant pleasure can lead to debt. Slowly there is a time when you are too much in debt, servicing your loan and paying EMI for various things.
“Debt is like another trap, easy enough to get into, but hard enough to get out of” – Henry Wheeler Shaw
It is so true. Find how these credit facilities make you fall prey to the debt trap.
Can you answer this simple question?
Mr.A takes a loan for Rs. 40 lacs @ 11% interest for 16 years. His EMI is around Rs.44,360 per month. He pays his EMI for 5 years, so pays in total Rs. 44,360 X 12 X 5 = Rs.26,61,600. How much debt has reduced from Rs.40 lacs?
You may say his debt has reduced to a big margin, looking at the amount he has paid. No, he has only paid for 5 years, he still has to pay for 11 years that is, Rs.44,360 X 12 X 11 = Rs. 58,55,520.
Let’s see in detail.
EMI (Equated Monthly Installment)
As you know EMI has two components, principal and interest. The principal is the amount you agreed to pay back. Interest is the cost of borrowing the principal. EMI is constant, but the composition of the principal and interest component keeps changing. A loan with high tenure will have a high-interest component in the starting and comes down later. There are two rules to know.
For any loan :
1. The interest component comes down as years pass.
2. The overall interest payable is high in long term loans and lesser in short term loans.
Prepayment of loans
Is there something as Prepaying of loans? What is prepayment?
Prepayment is when you pay an additional amount of principal back, ahead of time. This reduces your EMIs or your remaining loan tenure. This will make you spend less time in debt. The interest in any month is calculated based on your outstanding loan then.
How Prepayment helps you?
Now find how prepaying helps you. If you prepay your loan by a certain amount, your tenure period comes down.
Taking the initial example, let’s see how prepaying a certain amount reduces your loan tenure.
Eg : Rs.40 lacs loan @ 11% interest for 16 years tenure and EMI is Rs.44,360. Let’s say you paid EMI’s for 5 years, you will have another 11 years or 132 months to pay the remaining and after 5 years the outstanding loan will be Rs.58,55,520. At this time you can prepay some amount. Let’s see the effect of how tenure comes down if you prepay the amount at the end of the 5th year.
Here, at the end of 5 years of the loan payment, loan outstanding is Rs.58,55,520 and you need to pay for 132 more months. Imagine you got Rs. 21 lacs and you use it for prepayment, your loan will be over in just 98 months, a reduction of 50% in the tenure.
Won’t you want that?
Even if you prepay by Rs.1,77,440, you will bring down the tenure by 12 months. That’s a great relief for you. Clever home loan takers do this, as soon as they get money, they use it for prepayment and by doing so for some months or years, they finish their debt much before the scheduled tenure. Sometimes even in just 4 to 6 years.
The learning is that even a small amount of prepaid brings a big reduction in the tenure. This understanding is very critical to plan for your repayment faster. Prepayment has to be done whenever possible, even a small amount towards the principal over a long time repeatedly would bring down the tenure a lot.
Do loans help in tax saving?
Yes, they do but tax saving should not be a reason for taking a loan. If you already have one and areenjoying the tax benefits, it is saving you money at the end of the day.
How to pay off your debt faster?
You don’t feel free? Feel something is controlling you? You want to get rid of debt as soon as possible but it traps you, where your desire to take a risky decision goes down. Getting rid of debt fast is important if you want to take a bold step, as it helps.
These are the few ways in which you can pay off your debt faster.
👉 Increase your EMI
You can increase your EMI amount by 5 to 6% every year. This can be done when you have an increase in salary or other annual bonuses, increments, etc.
You may ask what’s the Impact or how it makes a big difference?
If you do this you will be able to come out of your debts faster and will also be able to reduce your tenure period to a great extent. You won’t have to stay in debt for long. You will also be free from the burden and stress and have some peace of mind.
Let’s see how.
Eg. You take a loan for Rs.30,00,00 @ 9% interest for 20 years. Your EMI will be Rs.26,992. If you increase your EMI by a certain percentage every year, see how your loan tenure comes down drastically.
This is how fast or how early you can come out of your debt. Won’t you be smart enough to do this? If you do so, it would be beneficial to you. You would save a lot of time and energy.
👉 Reduce expenses
You can’t reduce all your expenses, but you can always reduce 10%. You can aim to reduce a small amount. Big reduction is not possible as you won’t be able to do it in the long run. If you need consistency then a small amount is good enough like 10%. List down all your expenses and find which has the least value and cut down on it. Maybe you spend too much on food, clothing, accessories, or on things that are not greatly valued. Its time to restructure things and save on them.
👉 Use your next increment
You can use your future increments for prepayment, if not fully at least part of it can be used. You can plan to use it only for prepayment. If you don’t want to use the full amount you can use at least 50 % of it.
👉 Sell investments
You may have invested in low return products like endowment/money back plans and also would be paying off EMI on a high-interest loan. If so, you can liquidate those low return products and use them for prepayment. You can also redirect the money that was going into low return products into loan prepayment regularly.
👉 Use future inflows
You might not have the resources to currently pay off the debt, but you might be expecting income in the future like a gift from family, friends, etc. it’s a good idea to mark them for prepayment in the beginning itself. Most of them don’t do it and when they get the money, they use it for some other purpose.
👉 Take credit from friends
You take loans from banks, but not from friends and relatives. But for prepayment, you can ask if they have a surplus or extra cash and find if they can lend you at interest. Many have cash in banks like fixed deposits. If you can borrow money from them at interest, it will benefit you both.
Reduce your Interest Burden
- Choose a loan with the lowest interest rate.
- You can pay one more EMI (in addition to the actual number of EMI) every year. This will reduce your loan tenure and in turn the interest cost. If you can pay one additional EMI every year, you can reduce the interest burden.
Here is an easy EMI calculator to calculate the monthly EMIs.
- Choose an EMI you can afford. Keep affordability as a primary factor when choosing your EMI.
Should you Invest or Pay off debt?
You may have additional money, but don’t know whether to invest or pay off debt. This depends on you. How emotionally are you attached to a loan? Do loans make you uncomfortable? If yes, better get rid of it faster. If you are too afraid of taking risks and are going to keep the money in bank deposits, better pay off the loan.
- You can pay your loan online by linking your loan account with your bank account, this will help you prepay as soon as you are ready with the money.
- Check your bank’s restrictions on how much minimum and maximum you can prepay and include it in your repayment plan.
- Banks let you the option to either keep the EMI constant and decrease the tenure or reduce the EMI and keep the same tenure.
- You can ask your bank to increase EMI, in case of extra income, additional pay, increments, etc.
- You can also ask your bank to reduce EMI in cases like job loss, any emergencies, etc. If you had made prepayments, they might give you this option.
- If Interest rates go down, ask your bank to decrease your tenure.
Now you would have understood all about debts, prepayment and the advantages and effects of prepaying. It is better to pay off your debts as fast as possible because,
- You won’t have to be in debt for long
- You won’t be charged high interest
- You won’t be fined a penalty fee
- You can avoid stress
- You will get a good credit score
- You will start achieving your financial goals
- You will avoid bankruptcy and
- Get relieved from these debts.