Debt management is an integral part of financial planning. Your Loan portfolio has a big impact on your investible surplus. While doing cash flow analysis it is inevitable to analyse the loan portfolio so that it should be paid off or managed in such a way that interest outgo can be reduced and thus surplus can be increased. Higher the loan EMIs, Lower will be investible surplus. Where the loan portfolio is interest rate sensitive as in case of Floating rate home loan than macro economy will also play a key role in your personal finance.
To do a proper Debt management you should be having a 5D view of your portfolio, so you can weed out the unnecessary loan and thus improve your cash flow position. Following points will help you to find out the bad stuff.
1. Interest rate: This is the first step while analysing the loan portfolio. You should be having clear cut idea of the interest rate you have taken your loan on. Many people use their Credit Cards very frequently and are in a habit of rolling over the outstanding balance every month. One needs to understand that more unsecured and easily available loan is, higher will be its interest rate. Credit card comes with rate of 24%-36% p.a. Personal loan which is again unsecured comes with rate of 16%-18% p.a. If the interest rate is high the cash outflow would be more. Thus when there’s nothing you could be able to do for the closure of loans, sometimes it make sense to take one more for closure of other. Like if the credit card outstanding is high so rather than rolling over each month you should take a personal loan and clear your credit card dues.
2. EMI outgo: Your total EMI outgo excluding home loan should not be more than 20%-25% of your total in hand income and if there is home loan than EMIs should not be more than 40%-45%. Though Banks take care of this ratio while approving the loan application but the person who’s in need of loan always tend to find out his unique ways of dodging the bank. One should understand that higher EMI outflows distresses your personal life along with personal finance.
3. Type of Loan: Credit card and personal loan comes under unsecured loan category as you don’t have to pay any collateral or guarantee along with these. Whereas car loan, house loan, gold loan, loan against property/shares etc. are secured loans. There are some semi-secured loans too like education loans. As pointed out above, if the loan is unsecured than the interest rates will be high and so will be your EMI outflow. This will also impact your credit score negatively. Yes, even though you are servicing your loans well, high unsecured loans in your portfolio will reduce your credit score and you will face difficulty when you ask for other important loans. So if you are on closing loan spree than better to close the unsecured ones first.
4. Tenure of Loan: This is a very important point to consider. Say you have 2 loans with the same rate, same outstanding but the tenure is different than which one to close first. Keeping other things constant close the one with longer tenure. You have to do some maths here and may need to take help of some loan adviser or planner. Else you may call for the Loan schedule and calculate yourself the interest yet to be paid. In fact you should do this exercise on all your loans.
|
Personal Loan |
A |
B |
|
Interest rate |
16% |
16% |
|
Outstanding balance |
200000 |
200000 |
|
Tenure of loan |
60 months |
60 months |
|
Tenure left |
30 months |
16 months |
|
Balance Interest |
26298 |
6351 |
The above chart clearly shows that one should close the Loan A first as it will lead to more interest savings.
5. Tax benefit: There are few loans which provide you with some tax benefit too. Like Home loan provides tax benefit u/s 80C and section 24, Education loan provides tax benefit u/s 80E. If you are a business person you may also claim the interest payment on your car loan as expenses and can also claim the depreciation of that car. So while taking a view on your loan portfolio do keep in mind the taxation part. If there’s some tax benefit available, then the net interest outgo will definitely be less.
Cash flow management is very much required for a proper financial planning. As the whole exercise of financial planning is directed towards your goal so many times clients have to take some hard steps which may not be emotionally satisfying but are very much needed for a better personal finance. Debt management is one of those. Service your loan EMIs timely, don’t take loans for consumption or your desires, take good loans if at all required.
In the end, your Loan portfolio should not be a burden on your investment portfolio.