7 rules to follow when taking a loan

If we had enough money for all our needs, the world would have been a happy place. But the reality is different. Needs of modern households are constantly growing but earnings are not growing in the same proportion. This necessitates the need of loan to meet various expenses like buying a house, arranging a grand wedding ceremony, meeting medical expenses and in some cases paying off bundles of existing debts.

The gap between what we can afford and what we aspire to become is a huge opportunity for lenders. Technology has made it easier for the borrowers to compare interest rates offered by different lenders and check personal loan eligibility criteria before zeroing in on an option that best matches their needs. But, at the same time, the possibility of getting confused in a sea of options is not entirely eliminated.

So, here we will talk about the golden rules of borrowing.

Rule #1 Do not borrow more than what you can repay

This is the first rule of borrowing; you should not borrow at all if you think your needs can be met from other sources. However, if you do, your EMI outgo should never exceed 50 percent of your monthly income. Before you take a loan, calculate in detail using an EMI Calculator to find out the monthly EMI that you would have to pay in future. If the EMI makes 50-70 percent of your income, it will be extremely difficult for you to save for the future. In such cases, retirement funds and savings to fund your child’s education will have to be compromised. Borrow an amount that keeps your debt-to-income ratio within acceptable limits.

Rule #2 Never borrow to splurge

It is not advisable to borrow for discretionary expenses. For example, you may get several personal loan offers from different banks to fund your dream vacation but splurging on a lavish travel makes sense only when you have saved up enough. Taking up a debt for such entertainment expenses has the highest potential to pull you into a debt trap. Secondly, you should never borrow for investing. Any investment, including the most secure ones, cannot meet the cost of a loan. High-yielding investment options like equities are too volatile in nature and if things go wrong not only will you lose money but would also have to pay the EMIs.

Rule #3 Keep the loan tenure as short as possible

To lure the customers into paying smaller EMIs every month, banks offer longer loan tenures. The longest tenure is offered in case of home loan and it can go as long as 30 years. However, you should shorten the term until you reach an EMI you think you can afford because a long tenure also calls for higher interest pay-out. It may be tempting to choose a longer tenure as it would reduce your EMI but you should use EMI calculator to ascertain the EMI with different tenures and select the shortest one affordable in your budget.

Rule #4 Never delay the payments

It is the most important rule of taking any type of loan. Being disciplined will not only keep your payments organized but will also save you huge amounts that would otherwise go out as penalty or extra interests. Missing payments has a direct impact on your credit profile and hinders your chances of getting a loan in future. While it is extremely important to save and invest, we would not advise to do so by compromising on your debt payments. In case you do not have enough resources at hand to pay all EMIs due for the month, prioritise them in a way that you have to pay the least penalty and interest. However, you should not make it a habit; every EMI should be paid when due. The best way is to set standing instructions on your savings/current account for the payment of EMIs.

Rule #5 Keep looking for lower rates

Why should you keep paying high rates of interest when you can transfer the balance and avail lower rates? The financial market, nowadays, has become highly competitive so banks and NBFCs keep coming up with various offers. As a smart borrower, you must keep your eyes and ears open for such offers and make the most of them. The earlier you transfer your balance to a lower rate, the more benefits you can avail. Similarly, if you are looking to prepay your loan, compare the cost of this foreclosure with the amount you would save and opt for it only when the savings are significant.

Rule #6 Do not keep loans running just to avail tax benefits

The government offers tax benefits on some loans. For example, tax deduction on home loan is offered under section 24 and 80EE of the Income Tax Act. The interest paid on education loan is also fully deductible. Although these benefits come in handy to reduce the overall cost of the loan, it does not make sense to keep the loan running just for tax benefits. Compare the effective cost of loan with the returns that you could earn if the amount was invested. Unless you are getting a better return, it is good to use the amount to prepay the loan and get rid of EMI payments once and for all.

Rule #7 Read the fine print

Needless to say, it is extremely important to read the terms and conditions carefully before signing on the dotted line. Banks may have varied conditions for the same loan so do not blindly go for one. Also, you should not shy away from asking questions. It is better to be informed than to regret later. Ask the lender about the extra charges that you may have to pay under certain conditions. Lenders might slip in some extra clauses so you must beware.

Lastly, you should never keep your family in dark about the loans you have taken. Also, do not compromise your retirement savings to take up a debt. Consider all goals in your budget including retirement, your kids’ education, etc. and strategize in a way that none of your basic financial goals are compromised.

(Disclaimer: The opinions and facts expressed within this article do not reflect the views of News Nation. The NNPL does not assume any responsibility or liability for the same.)