It is probably the best invention since sliced bread—sliced payments. Known as EMI, or equated monthly instalment, it makes everything affordable (with a lot of help from credit cards, of course). Imagine the thrill of a spendthrift who has run out of cash when he sees this easy access to other people's money. It comes with a cost tag called interest, but high-rollers don't feel the pinch of a few hundreds.
So the shopping for debt begins. One loan to another, a new loan to finance the old one, one more credit card, then two, and so on. The metamorphosis from a spendthrift to debt monger is complete.
The problem is that people with heavy debt live in a state of denial. As long as there is enough money for expenses and payouts, all is well. Their savings take a hit, but debt addicts are confident of making up for these once the loans end.
Potnuru Kiran Kumar, 28, also refuses to consider high debt as a problem. The EMIs of his personal and education loan comprise 55.06 per cent of his net income, but he is not worried. "I am not concerned about savings. There is a lot of time for it," he says. Along with the two EMIs, Kumar is also rolling over a credit card bill of about Rs 27,000. His monthly income of Rs 25,000 is not enough to service all three forms of debt simultaneously. So the month he pays a part of the credit card bill, he foregoes the EMI of the personal loan.
Swot analysis
Strengths: Doggedness, despite a difficult path to the goal. Calm under stress.
Weaknesses: Need for instant gratification. Illusion of a rosy future. Lack of self-control.
Opportunities: Can rally around from tight money situations. Can juggle many commitments.
Threats: Can be sucked into a debt trap. Can be too scarred to take on good debt.
Most people would cringe at the idea of juggling so many loans, especially just three years into their careers. Not Kumar. He neither regrets his extravagant days at the engineering college which led to the personal loan, nor does he panic about the outstanding credit card bill. In fact, after three years of servicing loans, Kumar claims to have mastered the art of managing his cash flow around the payouts.
Today, some debt is essential for living. You will have to throw away credit cards, ignore bank loans, pay every bill on time and refuse to finagle relatives and friends for cash to be called truly debt-free. This is not possible. So most people take debt in limited amounts and for defined tenures. The idea of a loan going out of hand is scary.
In contrast, debt mongers are eternal optimists. Says Swapnil Pawar, Head, HNI Solutions, Karvy Private Wealth: "Such investors paint a rosy picture of the future, where everything moves in their favour." This is why they include uncertain sources of income, such as the variable component of their salary and expected inheritances, while calculating the debt they can afford. In addition, most debt addicts have an 'external locus of control', a phrase used by psychologists to explain the tendency of shrugging responsibility. Such people refuse to accept that high debt is a result of their actions and, consequently, do not think they can resolve the situation.
Therefore, planning for debt addicts must begin with convincing them of the problem. Pawar offers a simple formula: if the debt used to build depreciating assets is more than 30-50 per cent of your net income, accept that you are in trouble.
The second step is to ensure that you do not add to the burden. If credit cards are a problem, cut them up instead of shoving them under the mattress where you can reach for them when the urge to spend strikes. If you are planning to buy a new gadget on instalments, give up the idea. In fact, do not think of even good debt like a home loan till the total debt is within limits.
To shatter the false sense of well-being, Pawar suggests that you chop off 10 per cent of your net income while making any calculations. Next, add a buffer of another 10 per cent to your budget. This strategy has dual benefits: your debt affordability drops sharply and your cash flow automatically generates a monthly surplus. The investment rules for debt mongers are the same as that for spendthrifts: invest first and spend later. But before you tie up your money in long-term investments, consolidate your debt.
Start by ranking your debt according to the rate of interest. Typically, credit cards will top the list, followed by personal loans, car loans, etc. This is the order in which you must repay your debt. If you have investments that earn lower returns than the rate of interest of your loans, withdraw the money to prepay the debt. However, make sure that the money is not needed in the next few months.
In case you have different loans from the same bank, request it to combine them into the loan with the lowest rate. This strategy is called snowballing of debt and reduces your net interest outgo. If possible, do the same with credit cards too. However, scrutinise the bank's offer closely to ferret out any hidden costs that may upset your plans. Though borrowing to repay another loan is a strict no-no, experts make exceptions if the interest differential between the two loans is significantly high. So, don't close this option either.
Most importantly, do not break one debt cycle to be caught in a new one. When Kumar was asked what he planned to do with the money freed on foreclosing his personal loan, he replied, "I will spend more on entertainment. I also want to take a home loan next year. Of course, I will save a little." Kumar's priorities must be tweaked. If he starts spending lavishly, he may be forced to take on a new debt and push back savings by a few more years. If you are as comfortable as Kumar with debt, try to refrain from taking a needless one for at least a year. Once you live a stress-free life, all thoughts of financial masochism will be banished.
