Loans – the good, the bad & the ugly!
In today’s world, instant gratification of needs is the mantra. Everyone wants to own that luxury item, go for that dream vacation, buy that great car & they want to do it now! The concept of saving for your goals is alien to many people especially the younger generation.
Though we at Fpguru.com, being firm believers of financial planning & promote saving in the right way to achieve financial goals, we understand that in today’s world the same may not be possible for everyone. Some people do need to take debt to achieve certain life goals. However taking a loan is not entirely a good or bad thing. Loans can be divided in three broad categories –
The Good
Certain types of loan can help you achieve your goals & at the same time not just remain a liability for you. These are loans which usually create an asset. Loans for property & education come under this. Property loans if taken at reasonable interest rates & with the EMI’s falling comfortably in your monthly budget are ideal.
Educational loans also create an asset, a human asset. A well educated individual has a better chance of earning well & securing his future. An educational loan helps him in that. These loans usually have low interest rates if the educational institution in which the admission has been secured is of high standards. Also collaterals are only asked above a certain limit. The best part is however that the repayment period starts after one of the end of the course. This gives enough time for the student to get a job & start his EMI’s.
Business loans, too come under this category. Business loans are project based & loan details including repayment schedule can be mutually decided by the bank & businessman. All the loans mentioned can be taken to fulfil important goals.
The Bad
These loans are usually taken for consumption items. Car, household appliances, holiday loan, etc come under this category. These loans don’t create any asset. Your car depreciates, that holiday lasts only for ten days & that LCD TV will also get outdated within two years. Interest rates however vary for these loans. Many retailers offer exciting schemes for these goals. Some even offer interest-free loans. However there is no such thing as an interest-free loan. Such loans usually have high processing charges. These charges compensate for the interest.
Ideally you should avoid taking such loans & only take one for a high priority need. Also ensure the EMI payments do not form a big chunk of your outflows.
The Ugly
These loans do not create an asset & usually have very high interest rates. Personal loans & credit cards come under this category. These loans do not have any collaterals like the above two type. These means in case of any defaults the bank cannot claim you car or house. However this risk of the bank is compensated by the high interest rates charged by them. Personal loans are usually have interest rates in the range of 12%-18% p.a.
Credit cards are an even uglier. Interest rates range from 24%-36% p.a. No investment can earn such returns year on year! Such loans should be avoided like the plague. A credit card should only be used in an emergency.
Financial planning does not only deal with your investments but with your total financial situation. Debt management is a part of it. Making a financial plan will give you a fair idea of your debt situation. EMI’s payments should not be more than 35% of your income. It's ok to take good loans, avoid bad ones & banish ugly ones. If this principle is kept in mind, the liability side of you personal balance sheet will not look bad.
The article has been written by Jai Adiani. The writer is the founder of Fpguru.com
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