March 13 , 2013
Debts are something you should stay away from, maybe with the exception of money that is borrowed for acquiring assets not used for consumption. Most people that are overwhelmed by debts make borrowings that they think are manageable but are unable to make it.
If you already have debts, classify them into categories based on which ones to get rid of first. The best way to do this is by rating them on the interest rate and how much the assets purchased with the debt appreciate in value. You will have figured out that student loans and housing loans come in the least risky class because their value appreciates with time and interest rates are not exorbitant. Automobile loans come next because their value depreciates in time and the interest rates are higher. Credit card debt and personal loans are the deadliest of all.
If you have taken a personal loan whose interest rate ranges from 13% to 24% currently or have credit card debt strive to pay it off. Credit cards may seem to make life convenient but it can really be a debt trap if you do not know to limit your spending. Each time you buy on extended credit using a credit you will be charged a fee that can range from 30% to 40% per annum. Late payment fees are also painfully high. If you have to use a credit card choose one that suits your needs rather than one which is offered to you. But if you really cant discipline your spending habits just hide your credit cards!
Cut spending if you must
Make a commitment to allocate enough money every month to pay debts. This might require that you cut down spending. Its definitely not palatable but its probably the only way out. If theres nothing on which you can cut your spending down you might want to consider taking up an additional part-time job.
Alternative sources of borrowing
Whenever possible approach family members or friends who are able and may be willing to lend to you. You will get the money you need for lesser interest rates minus the tedious procedures involved in bank borrowing. This also gives one flexible payment options and may be even borrowing with no interest. Make it a point to lay down conditions of repayment in writing to avoid misunderstandings later on which can sour relationships.
You can borrow on your LIC policy from the insurance provider. Interest rate will be lower and you have the option of paying off the debt in installments or paying only the interest amount with the borrowed amount being reduced from the sum assured.
Switching of existing loans is more common in home loans. In a loan switching an existing borrowers loan is transferred to the new bank approached by the borrower. The new bank pays the outstanding loan amount to the original lender.
The benefit of switching is lower interest rate but this is not without other costs. Other costs involve pre-payment penalty to the original lender which ranges between 2% and 4% of the outstanding loan amount and processing fee to the new lender which ranges between 0.5% and 1% of the loan amount.
One should be cautious while going in for a switch given the fact that different banks raise or lower their interest rates not at the same time. Because one bank hasnt raised interest rates for some time doesnt mean they wont sooner or later. Only if there is a wide spread between interest rates of the two banks and several years of repayment left should you consider switching. Usually if the interest offered is lower by at least 1-1.5% it may be worthwhile to switch lenders. Similarly since interest component makes up the huge chunk in EMIs in the initial years it will make sense to switch during the initial years. Towards the end of loan tenure it is the principal that makes up for the huge chunk of EMIs.
Negotiate for lower rate
Try negotiating with your bank for lowering your interest rate. Although banks dont readily do this you might get through if you have a good credit standing and based on your past relationship with the bank.