06 December, 2010

Festive Binge can lead you to debt trap

Beware, impulse buying could spin your financial budgeting out of control.

Look around and you will find a million things you could spend on. The malls have a soothing effect for frayed nerves and people flock these places for entertainment and shopping. At times, we end up buying things even when we didn’t intend to. A simple session of window shopping could see us emptying our pockets and spin our monthly budget out of control. Lots of stuff bought on an impulse is never used and may not prove to be a prudent buy.

The easy availability of loans has made it easy for us to make purchases without planning for them. Almost everything is available on credit, from pizzas to overseas holidays, making enjoy now, pay later, a well-accepted motto today. But if you do not have enough cash flow to service the loans or if most of it is tied up in servicing of loans, managing finance can be difficult.

So, even while taking credit, one needs to be sure of the following aspects.

# Requirement: Whether the object or service in consideration is really required. And even if it is, should it be availed now or can be postponed for a later date.

# Loan warranted or not: A loan has to be paid off. So unless urgently required, there is no point in taking a loan for the object or service.

# Paying a reasonable rate: One needs to know, if the loan can be serviced easily or not. So check the outgoings per month besides having clarity on the loan repayment period. Many of us are unaware of the actual cost of the debts we have. For instance, loans which charge a flat 10 per cent may have other costs like the processing fees, late payment fees and so on. People are also ignorant of the interest they end up paying on revolving credit.

# Pre-payment options: Know the pre-payment options on the loan. If opting for a loan to tide over a temporary financial crisis, then a prepayment option with low penalties, is a good idea.

Planning ahead
If you really need to buying something, you could always put aside a small sum every month for a year before buying it. This way, the object of desire can be enjoyed sans any guilt.

But if you have taken a loan, consider converting it to a lower cost one. For instance, it may be a good idea to pay off credit card debts by taking a personal loan. There are loans that have a long tenure and are typically lower cost, like home loans. In the descending order of priority, if one wants to settle debts, credit card debt, personal loans, vehicle loans and home loans are the way to go.

However, not all loans need to be repaid in a rush. A loan availed at a cheaper rate can be retained.For instance, suppose a home loan interest rate is nine per cent. The actual interest incidence will be even less, due to the tax advantages. Hence, it may be a better idea to invest the money elsewhere, where the amount can earn a higher interest.

Facing financial crisis
One needs to explore ways to tide over a financial crisis without opting for a loan. If your bank gives an overdraft facility, it may be a good idea to use it. It will charge you only for the amount borrowed and for the number of days it is borrowed. Family and friends can also be a source of support. If you are confident of repaying in good time, by all means take the cash they are offering.

Stay away from unwanted debts. If taking loans is inevitable, look around for appropriate ones. This knowledge is worth its weight in gold.

Published in Business Standard on 17/10/2010

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