A couple of weeks back, in the personal finance checklist series, we discussed 8 ways to repay your existing loan efficiently and save money. And we told you there are some things to consider beforehand if you plan to take a loan for the first time. So, let’s discuss that.
Estimated read time: 3 minutes and 22 seconds
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Buckle up, here we go!
As we always say, debt is not always evil. Often it acts as a booster and speeds up your journey towards your goals.
Sometimes taking a loan might help you achieve some goals earlier in life or times when you don’t have a choice – an emergency.
But in all the history of loans, we have observed a few things that might just help you make your life slightly better while taking a loan.
The first thing is to consider whether you need a loan.
Excess or unwanted debt can take you on a downward spiral. It is important to know if a loan is required. And how much of a loan is too much?
One simple rule to find if a loan is required is to analyse the reason for taking a loan. If the loans help you build income-generating assets, that’s great.
But if the loan is for depreciating assets like cars, gadgets, etc, then you need to think about if it is a good choice.
You need to keep track of your financials to understand your capability to repay a loan. And to know how much of a loan is too much for you. Everyone has different repayment capabilities based on their income and assets.
A general thumb rule to check how much debt is too much is to limit all your monthly EMIs to under 40% of your post-tax income. So, if your monthly salary is ₹50k, your total monthly repayment towards these loans should not be more than ₹20k.
If you need help with your monthly budget, read here.
After considering your needs and budget, if you have decided to take a loan, the following points are some things to consider.
Major Loan Terms
Try to understand the terms and conditions of loans like loan tenure, interest rate, EMI, and down payment.
Compare interest rates from different lenders. Having a good credit score helps you here. Avoid taking an unsecured loan unless emergency. They have a higher interest rate.
Always try to tie the loan with collateral to reduce the interest rate. If you are afraid that you couldn’t pay up the loan and lose the collateral. You shouldn’t be taking the loan in the first place. Only take loans if you can repay them.
Most lenders will ask you to make a down payment. If you are planning to buy a car for ₹10 lakhs, they might ask you to make a down payment of ₹2 lakhs (20%), and they will offer a loan for the rest. If you could afford to make a higher down payment, that’s better.
Also, try to keep the loan tenure as short as possible while keeping the EMIs under 40% of your post-tax income. The longer the tenure is the more interest you pay to the lender. Check the below graph.
So choose the right tenure and EMI to minimise interest costs.
Minor Loan Terms
Often lenders charge you one-time processing fees, late payment charges and pre-payment penalties.
Most of the time, we forget to look at these minor terms of the loan that can pinch your finances silently.
You need to discuss these terms with your lender. A pre-payment penalty is a major concern.
Read our blog on how to repay loans quickly. It talks about how paying an extra EMI every year or increasing EMI by a small percentage can help you repay the loan quickly and save money. So make sure there are no pre-payment penalties.
Co-borrowing & Tax saving options
Sometimes, even when you have the money to buy something, it’s better to take a loan to avail the benefits of tax deduction. Investing your money in higher ROI assets while taking a loan at a lower interest rate is a plus too. But you have to be careful here.
Be smart with your tax-saving options. You can claim interest payment deductions on education loans. And claim both principal and interest payment deductions on home loans.
Also, did you know you can double your tax-saving benefits by adding your family members as co-borrower? And the interest rate might get slightly low if you add your wife as a co-borrower.
Plan these tax-saving deductions beforehand so you don’t miss out on them.
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