4 Common Debt trap to avoid

Monday, July 5, 2010

About a decade back, getting a loan had its own challenge. One has to visit bank a number of time and provide all the needed document/security before getting a loan, this has changed drastically in the last 10 years.

Most of us would get a call almost on a daily basis about loans & credit card from Banks. Its easy to get loans these days, but you need to ensure you have sufficient fund flow with you before taking up debt route to finance your needs.

Like a business man one have to effectively uses Loan (Debt) and his own funds(equity). High content of loan can get you easily trapped to the path of Bankruptcy. Lets see some of the common used loan facility.

Credit cards : A nice financial instrument, if effectively used and can be a financial killer if abused. No longer does one need to carry cash his wallet and ensure its security, if effectively used one get 45 days credit. Further these days, one get life time free card. Just paying minimum due would take you to the debt trap, plan to pay at the end of your credit period, if you feel due to commitment you would not be able to pay its better to postpone purchase unless its a necessity. Its not a wise, to pay credit card dues through a loan, unless its available at your disposal for almost negligible interest rate, if not Zero.

Home loan: The concept of Home loan has changed drastically in the last 8 to 10 years, now one can get home loans without visiting banks. Few years back, the Equated Monthly installment (EMI) was almost equivalent to the rent paid for an accommodation, hence it was wise to own house, since at the end of loan tenure the house or apartment becomes your property. The same is not true now adays, in the most cases rent is almost 1/3rd of the EMI, in case if you have opted by 85% financing through loan.

With sky rocketed property price in the last few years, one has to also take into account depreciation, if he opts for a flat. This being the case, if one calculates the total capital outflow till the end of the loan tenure vs the flat appreciated value, the total capital outflow might end up higher at the end of the loan tenure.

One might also end up paying more interest rate as compared to tax benefit available. Its better to keep home EMI 30 to 40% of the take home pay and take up decision after some home work is done.

Consumer loan: Any consumer product can be procured through loan, more particularly the vehicle loans. Considering the fact, consumer products have highest depreciation, its better to look at your needs rather than looking at the luxuries, while opting for this loan.

Personal loan:: Personal loan does not have any tax rebate and interest rate of quite high, these loan has to be used only if case of emergency. Personal loan & credit card loan are the first one which need to paid off as soon as money becomes available. The interest rate is much higher than home loan

Always keep a check on the cash outflow on regular basis and ensure some saving in form of the alternative investment is made on a monthly basis. Also, it imperative at any point of time the total of all your EMI is not beyond 50% of your take home monthly income. Though there is no hard or fast rule, its easier to save money at early age(between 20~30 years) than at a later stage(40 + years) of your life due to commitment one gets. Remember, unlike developed countries, India does not offer social security to its citizen during sunset years.

Pay check might increase over the years, but so is inflation and commitment over the years. Hence, one need to work according to a some financial plan.

Remember these days, the credit default information are updated into the database maintained by Credit information Bureau (India) Limited cibil . Hence, better not get into a debt trap, which can prove much expensive.

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