- Date : 26/11/2018
- Read: 4 mins
Living within one’s means and a prudent debt clearance practice can lift you out of financial stress
An extravagant lifestyle can land you in debt and cause immense financial worries and stress, as Vicky Sahu found out some years ago. A government employee, he wanted to give his family the best of everything. The problem? He tried to do it on borrowed money. Everything – his flat, wife’s jewellery, expensive education for the kids, flashy wedding gifts, vacations – was paid through loans and his credit card.
Admittedly, some loans were good debt, but there were also the outright bad ones; taken together, the loan stress crossed the threshold for Sahu after a point. It took careful planning and commitment, but eventually he did manage to solve his financial stress.
This is how he went about reducing his loan stress:
One of the ‘good debts’ Sahu incurred was a home loan; he needed a place of his own so that if anything happened to him, his family would not be on the streets. He also benefited from the tax breaks. But the monthly EMIs were killing him and he needed some relief. That was when he decided to refinance his home loan – also called ‘home loan balance transfer’.
Refinancing is a strategy where you, as borrower, negotiate with a new bank to finance your old loan – but at a lower interest rate. The new bank, which generally agrees as it is getting a new customer, pays the unpaid amount to the original lender, and charges you 0.5% -1% of the loan amount as processing fee. For instance, if your loan is Rs 20 lakh, it might charge between Rs 10,000 and Rs 20,000 as processing fee.
What stands one in good stead is a high credit score (over 750) on CIBIL. Sahu was in the clear as he always paid his minimum monthly credit card dues. He also ensured that the refinancing expense was less than his savings over the years; as his original loan of Rs 20 lakh for 10 years was taken at 9.5%, the interest was Rs 11,05,541; at 8.5% (new rate), the interest worked out to Rs 9,75,657, meaning Sahu saved Rs 1,47,884, which was more than his processing fees.
Sahu also started working on paying off debts. He read about the two principal methods of repaying debt: the debt snowball method and the debt avalanche method. In the first, you pay off your debts from the smallest balance to the largest balance, regardless of interest rates; in the second, you pay your debts from highest interest rate to lowest interest rate, regardless of balance.
Sahu found that the snowball method had almost a cult following; this was because people generally had multiple little debts (the grocer’s store credit, money borrowed from colleagues at the office etc.) and paying off the smallest amount due was enough to create a sense of accomplishment and motivate people to clear more debt.
It also appeals to people passing through a lean phase. Under this method, after knocking off some debts, they paid minimum amounts till the situation improved. But Sahu had a stable government job with bonus, and he had big debts: he found that technically, debt avalanche saves more money and gets one out of debt quicker. His annual bonus – a tidy little extra amount – also went into paying off the big debts.
Sahu also changed his credit card repayment practice. Earlier, he used to pay the prescribed minimum repayment – the lowest amount one must repay each month to avoid a fine. But the minimum payment is just a percentage of the balance. A big balance always remained each month; in fact, it swelled with more card use. All this meant he was in a credit card trap.
He resolved to not only stop the use of his credit card for non-emergency use, but also started making payments of big amounts every month, to bring down his outstanding faster.
Do not forget the difference between ‘want’ and ‘need’. Keep your credit card for emergencies and convenience only, and do not let family or friends entice you to go on a binge ‘just this once’. No, you must live within your means and not on credit. Use a debit card instead.
This may not work for everyone (nothing works for everyone!) as many people cannot draw the line between ‘want’ and ‘need’ and are incapable of living more frugally. But that is exactly what is needed to get out of debt!