Reevaluate your financial strategy before opting for a big loan

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“The whole time I had the burden of my home loan on my head, it made me realize that all my financial plans had gone wrong because I hadn’t bothered to plan things out in detail beforehand. to apply for a loan from the bank.. Watching how EMI payments would trickle down to other aspects of my finances continues to haunt me and when the pandemic hit, things got immeasurably worse. Anshul Choudhary (name changed), the COVID-19 pandemic could not have come at a worse time.The 35-year-old management professional and his wife welcomed a baby in early 2019 and shortly after the couple decided to buy the house of his dreams.

Getting a loan from the bank was a smooth experience. Choudhary had envisioned that his wife would start working again and that he could also easily transition to a better paying job so that their increased income would make the debt burden a little less painful. However, the coronavirus pandemic has been a brutal shock and much to the couple’s dismay, servicing EMI payments has become a Herculean task, with his wife unable to find a job and Choudhary facing the brunt of a pay cut.

Although easy access to credit is a boon, it is also a double-edged sword. Knowing that you can easily tap into a pool of credit to meet your goals and pay it back later can create an inappropriate sense of complacency that leads many people to take on debt that may not match their financial capabilities.

Know your repayment capabilities

Anuja Agarwal, managing director of InvestAscent Wealth Advisors Pvt Ltd, believes that the biggest question to ask yourself before taking on a big loan is how this decision affects other areas of your finances. “It is always important to look at the holistic aspect of any decision we make, whether it is about our health, our business, our career, our home and especially our finances. Fulfilling our desires is the easiest thing to do today, but you have to ask yourself: can I afford this loan? If so, what happened to my other critical goals?”

When assessing your repayment capabilities, it is also important not to give in to the temptation that it is acceptable to divert financial resources for other purposes towards loan repayment. Agarwal says, “Investments towards goals such as children’s education, retirement, emergency medical expenses should not be compromised for payment of IMEs, especially if the debt was incurred for indulgences or recreational activities. Before taking out a loan, make sure that you would be able to manage your regular expenses and investments while repaying the loan.

Parvati Iyer, chief investment officer at Femwealth.com, an online investment management platform, believes repayment capabilities are the first thing to consider before deciding to borrow. “Whenever one takes out a large loan, the ability to repay it must be determined. A little planning can go a long way to ensuring that you don’t end up in a situation that will only get worse over time. This means that there is enough revenue to cover IMEs. The best case scenario is obviously to save and invest in the lens of that expensive item. But as this is not always possible, it is necessary to compare current income with expenditure. Your current financial strategy would have included investing in equity and debt mutual funds to achieve the goals you aspire to achieve. One of the first things to check is whether investments in current goals can be continued uninterrupted,” she explains.

Adjust your investment plans

SIPs in mutual fund investments can significantly reduce your EMI burden. While many people tend to forgo investments in favor of debt reduction after taking out a big loan, a dedicated SIP plan, even if at face value, can go a long way in reducing the amount you you would pay as interest to the bank. For example, if you have a home loan of 25 lakh at an interest rate of 9% per annum for a term of 20 years, you will have to repay approximately 54 lakh by the end of 20 years and your EMI will reach around 22,500. Now if you invest even 0.1% of that ( 2500) in an equity fund through SIP and assuming it offers a 12% rate of return, your investment would be 24.7 lakh in twenty years and that capital appreciation on your investment will significantly offset the interest on your home loan.

Iyer suggests that if a situation arises where one is forced to compromise on current capital expenditures, it may be useful to compare projected rates of return for a few goals with lending rates. “Generally, loan EMIs tend to carry a higher interest rate than debt fund returns. Most short-term goals tend to be funded by debt funds. Therefore, your financial strategy should consider delaying some of the short-term “wants”, such as holidays abroad. In the worst case, key goals such as retirement may have to be delayed for a few years to account for reduced investments while maintaining the same asset allocation. However, the calculations may make such goals untenable, in which case it is best to avoid the big loan. Changing the asset allocation or expected rate of return for s Adapting to your financial strategy is guaranteed to be a disaster,” she says.

She points out that over the long term, the benchmarking exercise should also take into account the expected returns of equity mutual funds, as they are primarily suitable for long-term investments and expected increases in income, if possible. “Generally, for a simple wealth-building goal, if your projected equity mutual fund returns are higher than the loan rate, equity investments could be pursued at the expense of longer loan terms. It is best to make such comparisons over a longer investment horizon in which ripples in equity returns can level out. If you have good visibility on future revenue increases, these increases could also be factored into your financial strategy.

Key points to remember

• When taking out a large loan, you must ensure that your emergency fund is sufficient to cover EMI repayments for at least six months.

• Never underestimate the power of a good term insurance policy for you and your family. There can be no worse financial nightmare than having no funds to cover emergencies. When you take out a big loan, it can become more difficult to get through such circumstances without the buffer of an insurance policy.

• Keep a close eye on your credit score and, if possible, clear your credit card debt and existing loans that are smaller before you take on a big loan.

This article is part of the HT Friday Finance series published in association with Aditya Birla Sun Life Mutual Fund.

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