“Debts! Debts” – The most common and hated thing across the globe. No one likes getting into debt. But it is one such thing that happens inevitably.
Debts are not always bad. There are good debts as well. Good debts take money to make money. If the debt taken is generating income and building wealth, then it is a good debt. On the other hand, if it is hampering the income and investment opportunities, then it is bad. Below mentioned are some of the powerful ways that help in reducing the bad debt and increasing the overall investment income.
1. Planning A Budget
One common mistake made by most people is not creating and following a budget. Having track of the expenses and budgeting things based on the net income, can amplify the potential savings thereby the investments. With a well-planned budget, handling finances and debt repayment becomes easier and more trackable. Its further acts as a road map and is an invaluable tool for managing debts, etc.
Solution: There are two recommended solutions.
- Normal budgeting – Recommended if the debt is high.
- Reverse budgeting – Recommended if the debt is low.
1. Normal Budgeting:
The 50-30-20 rule. In 100% of the net income,
- Allocate 50% for the rent, bills, insurance, debts, etc.
- 30% should go to the needs. This, 30% should be used for investing. Be it Investment In Stock Markets, real estate, etc.
- 20% goes for the fun part. This is like a party fund. Planning abroad trips, setting up an emergency fund, etc.
2. Powerful Way to Increase Your Savings (Investment): Reverse Budgeting.
With reverse budgeting, goals come first, and spending comes next. From the net income, instead of allotting 50% of the income to expenses, in reverse budgeting, that 50% is first dropped into the investment portfolio account, and then the rest money must be managed accordingly. Let’s understand this with an example: Here, in 100% of the total net income,
- 50% goes to investment.
- 40% goes to regular expenses, debts, etc.
- 10% is the Enjoy-It-Yourself Fund.
Reverse budgeting gives an idea of how much income must be increased to meet the set goals, needs, etc. This gives the required motivation to look out for more potential opportunities to create passive income.
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2. Never Give Up on Investing While Clearing the Debt.
“Wealthy people invest first, spend next with the rest whereas broke people spend first, invest the rest”.
While paying off debt, it is very easy to let go of all the financial planning. Putting aside that usual chunk of funds that is set for investing should never be neglected. Sometimes the fund can become tiny due to many reasons, and that’s fine. But completely shying away from it should never be done.
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3. Is minimum payment best?
The other common mistake most debtors make is repaying less percentage of a loan. “Paying back less” initially might seem to be a good way to earn more but can become “highly costly” if not utilized in an effective correct way. When minimum payments are being made, it is mostly the interest and a little actual debt that is being paid. This extends the repayment period of the loan, and thus makes it difficult to take another loan.
Example: Let us take a small example.
Let us say a person named Mr. Abhi took a loan of 10 lakhs (dated November 2022) at an interest rate of 12%. The time span chosen to clear the loan is 30 years. Then,
Required EMI to pay = Rs.10,286
Loan closure year = November 2052
Total amount to be re-paid
(Which includes interest) = Rs. 37, 03,005.
This means the total amount repaid is more than thrice (almost close to 40lakhs) the original amount. The EMI Rs.10,286 mostly constitutes the interest amount which is Rs. 12,000 for the first month.
On the other hand, for the same amount of loan, keeping the interest rate same, if the time period becomes 8 years, then the required EMI to be paid becomes Rs.16, 253. With this EMI, the total amount that would have been repaid by the end of 8 years would be Rs. 15,60,273.
4. Taking Multiple Parallel Debts
Opting in for a parallel loan when a loan already exists can put debtors in a more difficult financial situation. This can make the debtor unable to manage the finances. It can make them confused and burdened, which results in unmanaged, unclear financial decisions.
Note: It is also important to note that non-payment or late payment of either of the loans hampers your credit score.
Fun Fact: Using a credit card can turn out to be a remedy if used in an efficient way. This is discussed in point 5.
5. Planning the Loan Repayment:
In this method, the credit card/loan with the lowest interest rate should be paid first. After paying off the card payments, now, using the same card, pay off the next loan with the lowest balance. This process can be continued to pay off the cards one after the other.
Note: This method should be used in an effective, disciplined, and planned manner. If not, this can result in disastrous loss.
Don’ts While Taking Your Debt.
- Spending beyond your means: Credit cards shouldn’t be used for purchasing things that are out of affordability. A credit card gives an illusion of unaffordable things to look affordable. Hence one should avoid buying that doesn’t seem affordable without a credit card.
- Availing loans with a very high-interest rate.
- Say “No” to a very high number of credit cards.
Do’s In Financial Planning to Avoid Debt:
- Dig deeper into your expenses. Cut down the unwanted expenses by reducing the wants and focusing on the needs.
- Timely payment of credit card bills, etc.
- Negotiate with creditors to make debt repayment more manageable.
- If there are multiple loans, start by repaying the loan that has a high-interest rate first.
- Don’t completely stop using a credit card, managing it in a highly effective way increases the credit score.
The interest amount/the money generated through a debt should always be high than the interest that is being paid for a debt. To know more about finance, Stock Market Investment opportunities, the Goela School of Finance Online Stock Market Course in Pune, and online acts as a ladder to financial success.