I am sure everyone like to be debt free way but strategic planning is needed to be debt free in this era of gadgets and easy loan options. I have been offered lot of easy money option in terms of credit card and no paper work personal loan. Though I have never opted for any such loan and pay them over the moon rate of interest but rather I milk my credit cards efficiently to generate lot of cash out of them. Actually most of my wardrobe is sponsored by my credit cards only. If you want to know how I do it check out in this article.
Coming back to the topic of being debt free, I see people make really simple mistakes (of course forced by the lenders many a times) that push them into more debt and not out of it. So let me share with you how you can avoid such mistakes in the first place and then plan a way out of it.
1. Know your Debt
No I am not talking about the interest rates and EMI details but what I am talking about is how much debt you are left to pay off. If you have multiple EMI’s running under different loans, make sure you have the right figure of how much money you owe to others. This is very important for any individual because once anyone knows how much he owes then only he can take the next step towards reducing that amount.
When I ask people about – How much is your debt? Most of the time the answer is I have taken a loan of X amount and have been paying so much for so long and so it should not be too much left for now. These people don’t understand the basic concept of EMI’s at all because EMI’s don’t work that way. You actually pay more interest as you start the loan and it is only after half the tenure of loan has passed when you actually start paying the principal amount in majority. You can check out How EMI’s Work here.
So if you know how much you owe to others, you will not only understand the concept of EMI (once you pay an EMI and don’t see much reduction in your principal will force you to understand how EMI works. I understood it that way only. :D) but can also have a strategy planned to further reducing it.
Let me share with you a simple example of how knowing the debt helps.
You can have two EMI’s at same or similar interest rate. So we take an example of a Personal Loan and a Mortgage Loan where you have slightly higher interest rate for personal loan. For argument sake we take 15% for personal loan and 14% for Mortgage loan.
Now if you think about prepayment, it will always be for a personal loan that will have a preference over Mortgage loan.
That may not be the right decision.
Let me share with you how and why.
Personal loans is a short term loan with a time period close to 5 years but Mortgage loans are for longer term loans of 10 to 15 years. If both loans started almost at the same time then there are more chances that EMI for your personal loan has reached a time where payment to principal part is in majority than the payment to interest part but for Mortgage loan it could be the other way round.
So which loan should be paid first?
Yes you are right this time. The right strategy is to focus on prepaying the one where you are paying more in the interest part and less on the principal part.
2. Don’t be fooled by Banks
Pre payment costs money and this money makes us to believe that once there is a big chunk of money to pay off, it makes much more sense to be making a prepayment. Isn’t it?
The charges is just a mind game to avoid prepayment because if you prepay even equal to your EMI amount, you will surely save few times of what they charge as prepayment charges.
Personal loans are the ones where there are maximum prepayment charges and so let us see an example of how we can save few times making a prepayment even in personal loans.
A personal loan of 100,000 at 15% rate of interest for 5 years has an EMI of 2379 per month. In the first year of the loan tenure the interest part for the loan is always above Rs. 1000. So even after a complete year, you just prepay 2379 Rs with a prepayment charge of 500 Rs, you actually save 500 Rs because interest is anyway above Rs 1000.
There are many more tricks used like they say that they will not reduce the EMI but change the tenure of the loan. No matter what tricks are being used, they are meant to make sure you don’t prepay and so accept all terms and conditions and make the prepayment like you opt when going for a loan. You don’t tend to read those terms so why now.
The next trick out of the bag when you opt for prepayment is to show you good investment options instead of prepayment. Feeble-minded people fall in the trap to either prepayment charges or investments option. What if you can invest money and generate return close to what banks makes from you. Still I see that people in loan have investment plan to beat the interest rates of the banks and I always prefer investing in my loan.
3. 3 Point Reminder to be Debt Free
Take pen and paper and write 3 goals for your debt.
- A monthly or quarterly amount you plan to reduce your debt by.
- Yearly amount you plan to reduce your debt by.
- A Timeline when you can be debt free and then squeeze that timeline by 10% to 20% to keep make your targets aggressive.
The larger term goal is what you should aim for but having a smaller term goals help you to achieve the larger goals and judge if you are moving rightly towards the larger goal.
Now just creating the reminder is not enough and so you have to make a screenshot out of it or take a snap of your writing and put that as your Desktop Wallpaper. It
4. Opt for Interest Free Loans
You can always ask money for a short duration of time from your friends or relatives or family members and use it to pay towards your debt. The golden rule that I follow when borrowing money from friends and relatives is to borrow only such an amount that I can prepay in a month or two. I am bit more relaxed when borrowing from family members where I try to pay back in maximum of 6 months. The target for family members is 3 months but this loan tends to drag slightly more than that. The idea is to pay off a debt so you have more money to throw at the next one.
5. Sell Your Luxuries or Defer Buying
Make a list of your luxuries that you think you are fine not having for the next couple of years and then sort them in decreasing order of pricing that you can fetch selling them off. If the highest priced item can fetch you a significant amount that can impact your debt, Just do it (No its not a Nike Ad). By significant I meant clearing the debt by a minimum of 20%. The same logic can be applied to buying a luxury as well. If buying the same luxury like a car or bike or jewellery can increase your loan by 20%+, it can always be deferred provided it is a luxury. At times car is a necessity but make sure you make the right decision of understanding if it is a luxury or a necessity.
Leave a comment saying how you plan to go debt free. Be Specific.