Acknowledging that you are over leveraged is one of most important steps to get debt free. If you understand your finances, you will learn to manage them better. We have all gone through phases in life when we release that we are spending more than what we are earning and its important we understand this and take steps to manage things better.
Understand your debt: I have learned to split my debt into 4 parts
- Revolver: high cost debt usually linked to credit card spends or cash loans where interest loans are too high and not paying on time results in multiplier effect on outstanding.
- Live life debt: EMI loans linked to buying products or holidays. This type of debt is usually not visible as it gets camouflaged under subvention or supplier funding.
- Asset class debt: long term loans of cars and homes.
- Liquid class debt: using asset class products to take a loan like Gold loan, loan against property.
Some board thumb rules:
- your loan amount should never be more than 8X your annual salary.
- Revolver loans should never be more than 50% your monthly salary.
- Total EMI should not be more than 50% of salary
Quick solutions to reduce debt burden:
1. Balance transfer: Banks offer to people with large outstanding the option of balance transfer from one credit card to another. You can opt for a fixed duration balance transfer(3-12months repayment), in such transfers interest rates are usually 9 – 15% depending on your bank. Some banks also offer a ‘Lifetime duration’ option to make the repayment, though interest rates can be much higher (12-24%). Please note banks also levy process fee, which usually is 2% of the outstanding amount. After the bank verified your details, they will send you the cheque on the demand draft in favour of your existing credit card that you can use to repay.
2. Converting outstanding balance to a EMI: usually if the net outstanding across credit cards is too high I will suggest you can take a small personal loan and repay your credit cards. Please note credit card debt comes at above 2% interest per month (36% – 46% per annum) and also attaches service charge while a simple personal loan will cost between 12-16% per annum.
3. Negotiating lower interest rates with existing bank/institution or look at loan transfer: most institution allow some amount of negotiation usually linked to a bullet payment.
4. Salary cover to paying credit card outstanding : usually credit card outstanding can be managed by paying over two salary cycles and managing funds better. Pay day or bridge salary loans like EarlySalary can be very usual in such stages.
5. Loan against FD’s or Gold Loan: loan against asset comes at much lower interest usually loan against FDs come at 2-4% while Gold loans come b/w 4-8% per annum and thus are very good way to reduce debt burden.
Simple life rule to manage finances be save 30% of salary and don’t leave more than 25% in EMIs.