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High levels of debt can mean that your savings and investment goals are compromised. Prioritise repayment or restructuring for long-term benefit
An important annual exercise in managing your finances is to review your debt situation. You need to know what your debts are to be able to have a plan for its repayment.
The new refrigerator, credit card spending on the family holiday, the personal loan all add up and suddenly much of your income is going towards repaying loans, leaving very little for saving and investing for your future. Knowing what your existing obligations are and seeing its effect on your finances can act as a brake on taking additional debt.
While an annual review can trigger a course correction, it can also act as a motivator to continue responsible behaviour where the review shows that you were prudent in taking and repaying debt.
List and assess your debt
List all your debt irrespective of size or who you owe. This will ensure that you don’t miss out on any obligations and your repayment plan considers all of your debt. Put down the amount outstanding, the term of the loan, the interest payable and equated monthly instalment (EMI). Knowing the details of your debt will help you better deal with it.
All debt is not the same. The impact on your finances of different types of debt can be significantly different and will dictate how you deal with it. Some, like credit card loans and personal loans, have the highest interest costs and servicing them will be a strain on your income.
You should plan to pay them off as early as possible, so that your income can be freed up for your saving goals. Home loans and auto loans are secured on the assets and you stand the risk of losing them if you don’t meet your obligations.
These loans should get priority claim on your income for repayment. These loans are serviced over a long period and should, therefore, fit into your long-term financial plan.
Knowing what portion of your monthly income goes towards servicing your debt will tell you how secure your financial position is. Include all repayment obligations, whether mortgage payments, auto and consumer loan EMIs, or minimum due on credit cards when calculating what you need to pay each month, and then compare it to your monthly income.
Higher the proportion, greater is the risk to your financial security. Your ability to save and invest will be limited by the repayment obligations. It is a trigger for you to look for ways to get your outstanding debt under control.
Make a debt plan
The longer you carry debt, the longer will be the period for which you will pay interest cost. The debt plan should, therefore, not only consider servicing the debt but also paying down the debt as soon as possible.
A budget comes in handy to trim and streamline expenses so that you can find more savings from the available income to deal with debt.
Rank the debt so that you know which debt gets priority in repayment and pre-payment. Home loans and auto loans get priority in servicing the monthly EMIs because a default has serious consequences like foreclosure and losing the asset. Payments due on credit card and personal loans are expensive loans and should get first call when you have additional funds in hand and are looking to repay loans.
Some loans, like education loans and home loans, may have tax benefits that bring the effective cost down and reduce the strain of repayment. These are loans that you need not hurry into pre-paying. Or, you may decide to close the smaller loans first to give you the psychological satisfaction of taking it off the list.
Cut the costs
You should consider opportunities available to reduce the cost of borrowing. You may be able to refinance your mortgage and use lower-cost loans to repay higher-cost ones. Credit card balances can be transferred to those with lower interest costs. Or, you may have the option of repaying the balance as EMIs at lower interest costs when you transfer balances.
Look beyond the interest costs to others fees and costs associated with the refinancing. Where lower cost secured loans such as loans against investments, gold and real estate are being used to refinance higher cost loans, make sure you are disciplined with the repayment so that your asset is not at risk.
Monitor your credit profile
Your debt profile is captured by your credit score and credit report. Check your credit report periodically to make sure that there are no errors or oversights. Inclusion of loan accounts and credit facilities that do not belong to you and omissions and errors in updating repayment and closure of loans can affect your credit score.
Get the errors rectified quickly so that they do not affect your credit score. A low score will lead to higher costs of borrowing and you may even find yourself unable to access credit facilities in times of emergency.
Being organized is important to being able to deal with debt efficiently. Sign up for automatic payment of EMIs and credit card dues so that there is no delay or oversight. Make sure the bank account is adequately funded.
Keep loan documents, repayment proofs, loan closure documents and others handy for reference.
Update your debt situation periodically. Seeing it in black and white can act as a motivator where you have managed to reduce debt and as a warning and need for action if it is going up.
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