HOW TO BORROW SMART

Credit can be a blessing or a curse. It can help you achieve many of your financial goals but it can also put you in a financial crunch. Know how to become smart with debt

Rising inflation, pressure on income and skyrocketing expenses have made household budgets go awry. Mumbai-based Ramesh Tripathi had a subdued 50th birthday celebrations in 2021, as his family of five, including his wife, two teenage children and 78-year-old mother, grappled with the impact of Covid on their lives. The uncertain period had made them stretch their financial reserves. “I was paying a home loan and had also taken a personal loan to purchase a second laptop, as my daughter needed one to manage her online classes,” he recalls. He is not new to taking loans and understands its advantages.

At one point, the Tripathi family paid almost 60 per cent of their income towards servicing loans. They had a loan on the house, a car, and some gadgets and had added a personal loan just to keep afloat for a short period. His older son had taken an education loan for his graduation, but with the pandemic setting in, his employment got delayed than the time frame he had anticipated. Their family is like any other that grapples with financial burden every now and then, when savings just don’t seem to be enough.

Meanwhile, 24-year-old Aditya Shetty, who lives in Bengaluru, is relieved for the payday loan that is

SIMPLE HABITS CAN MAKE A BIG DIFFERENCE IN YOUR PROGRESS TOWARD PAYING OFF DEBT. MAKE A BUDGET AND STICK TO IT

available on a lending app he swears by. He has taken the loan every month since early 2022. “With no increment in the past two years, and rising expenses, I find my savings gone before the end of the month. I don’t wish to ask my parents for money,” he says justifying his dependence on a payday loan. Payday loans are meant for the working class who have difficulty in making ends meet, and are often broke at the end of the month.

There are many youngsters like Shetty, who find it difficult to manage their finances on their own, which makes them borrow for essentials. The easy availability of loan for almost all kinds of things has made many of them forget the concept of savings and budgeting.

They live pay cheque-to-pay cheque, servicing EMIs (equated monthly instalments). Many youngsters believe in the power of easy credit to be a boon that makes them realise their financial goals and aspirations in a short time. The great Indian festive season on mobile apps and stores marking prices of products with EMIs instead of MRP is an indicator of where things are headed.

MANY SHADES OF DEBT

A strategic use of debt may help you achieve your short- and long-term financial goals. Sometimes, the smart move is to borrow in order to achieve your goals ahead of the time it would otherwise take to save for it. Setting aside Rs 3,000 every month for a year and then buying the

latest smartphone seems to be too much of a wait when the same can be done right away with a consumer loan. But knowing which loan is good and which isn’t is a useful exercise and is easy for everyone to understand and follow.

Whether the debt is good or bad depends on several factors and knowing how and how much you should borrow can be confusing. Moreover, the type of loan that may be right for you depends on your unique situation, which means you need to figure the best way to incorporate smart debt in your financial plan. There are certain common factors when it comes to borrowing—your existing credit score, the interest rate on the loan you take, the tenure of the loan in which you would repay it and the amount you borrow itself. You also need to factor in your unique tolerance for debt.

The simple difference between good and bad debt is based on the fact that good debt is borrowing that helps you build long-term wealth and bad debt is one that can harm your credit score and deplete your finances. There are also risks and costs associated with borrowing, which borrowers sometimes ignore at the time of taking a loan. For instance, short-term unsecured loans often come at high interest rates and penalties compared to a long-term secured loan like the one taken to buy a house.

Often, people have their first brush with a loan for when they start earning and get their own credit card. The credit limit on a card is often assumed to be savings, which can be easily used up without realising the aftereffect of doing so. “My credit card got blocked because of repeated delays in repaying the outstanding and my irregular repayments,” says Shetty. At the beginning, he was meticulous in paying the credit card outstanding on the due date. But then he started using the card on everything he spent on, which resulted in overspending. “My spending went out of control and soon I maxed out on the card,” he adds.

Credit card debt is probably the most common example of bad debt. It is a bad form of debt because of the high interest rates. Loan on white goods and consumer goods is the next culprit. Vidya Shah, a 46-yearold Mumbai resident, purchased a microwave in 2021 worth Rs 14,000 from a large-format retailer. As she was about to pay for the microwave, a smart loan salesman lured her into a six-month easy-to-repay EMI with zero per cent interest on the sale. She was tempted at the offer because all she had to do was pay an additional Rs 200 and the loan was backed because of her existing debt card.

“I saw it happen before my eyes. I had the money, I wanted to pay in full and then this boy got me talking and within minutes I felt I had saved the money instead of spending what I had saved up for in one go,” she says. Once Shah reached home and checked her transaction, she realised that she was outwitted by a 20-something salesman. She had paid for two EMIs to pick her microwave, which meant instead of 6 months, her EMI was for five and she had paid the processing fee. The microwave now cost her Rs 14,200 instead of Rs 14,000.

Big retailers of white goods, mobile phones, laptops and even clothes have figured a smart way to attract consumers—push year-long sales through offers. Along with banks and manufacturers, they have devised zero per cent EMI schemes. There are two variants in such offers—one, where there is a processing fee, which amounts to an interest charge. The other is a subvention type scheme where they do not charge a processing fee, but the interest component is borne by the card issuer or the retail merchant.

“I did not understand why retailers would absolve the interest or processing fee. I believed that I was get

ASK MORE QUESTIONS WHEN YOU ARE TAKING A LOAN TO UNDERSTAND WHAT YOU ARE GETTING INTO. IT WILL MAKE YOU REALISE WHAT YOU ARE PAYING FOR

NOT ALL DEBT IS BAD. SOMETIMES IT IS BENEFICIAL TO LEVERAGE THE POWER OF CREDIT TO REGAIN OVERALL SOUNDNESS IN FINANCIAL HEALTH

ting a good deal and landed up buying two other goods that I needed on zero per cent EMI,” adds Shah. She is not alone. There are scores of men and women, many highly educated and qualified, who forget the fact that often such schemes make you buy things you do not need or buy them at prices beyond your budget. The lure of easy money makes all such purchases a very poor form of borrowing. All these schemes are too complex to understand for lay consumers.

Often, product manufacturers phase out models selling them through retail chains. If you try to ask for a discount on such items on the basis of paying upfront in full, retailers do not entertain such deals. Many products are not available on cash at all; they are available only on EMIs. And if you insist on paying it all upfront, they will agree to accept it including the additional processing fee that you don’t need. Eventually, you may be lured into buying something more expensive than you had set out to buy.

The regulator—in this case the Reserve Bank of India (RBI)—from time to time does step in and ask for greater transparency in pricing and the charges levied. However, such intervention occurs after such schemes have done their deed. By camouflaging the interest component by way of processing fee and passing the same to consumers is a common trick. In desperation for a sale, sales agents often reduce the processing fee to a miniscule sum just to meet their targets. In the larger scheme of things, the retailer, financier and the product manufacturer benefit; the complexity of all such deals is never visible to gullible consumers.

Yet another form of loan that is high-cost is an auto loan. Simply put, it’s a loan used to buy an asset that depreciates. Financially speaking, it is like borrowing to support ongoing living expenses, which is not a wise move. When Tripathi was buying a car, he was clear about the model and range he could afford based on his needs and repayment capacity. The dealer tried influencing him to go for a higher-priced model, but he stuck to his guns. “I didn’t want to pay more EMIs because I knew it would be beyond my budget,” he explains.

A good form of debt should be able to help you accomplish your objectives. Education loans are probably the most common example of good debt after housing loan. Given the correlation between a college degree and higher earnings throughout your career, it makes sense to borrow to fund education. Taking a home loan is another common example of good debt because for most people, it’s not possible to pay for a house outright. Paying home loan EMIs results in ownership of a home as well as potential tax advantages, which could make the cost of borrowing go down.

There are broad-based rules when it comes to borrowing (see Borrowing Thumb Rules). These can help you know how much you can ideally borrow and when not to go overboard with borrowing. The actual range for each of these indicators may vary from individual to individual and their earnings, financial situation, risk-taking ability and credit score. But, a benchmark is a good starting point to know how much you can afford to borrow.

HOME LOAN AND TAX BENEFITS

To encourage home ownership, the government has allowed for tax concession on home loan repayments. The tax advantage can be claimed on both the interest and principal repayment each financial year within limits. Combining these two, a borrower can claim as much as Rs 3.5 lakh in tax savings in a financial year. The tax benefit on home loans can be used smartly to maximise savings, especially if the loan is taken jointly (see Joint Loan, Greater Benefits). This is one move