8 Jan 2014

How Does One Get Into Debt?

How does one get into debt? This is a question I have pondered over many times.
Yesterday, a colleague (let us say his name is Steve) mentioned that he has Rs.30, 000 in credit card debt.  
Steve is in his early to mid-twenties and has been with the company for over three years. I asked him how he got into credit card debt. He shied away initially but then narrated an incredible story.  He is one of those who bought things he wanted and “believed” he could pay it off. However, he did not crunch the numbers practically and now he is stuck with debt. I asked Steve how much his interest rate on the credit card was. His response was 2.65 %. However, 2.65% is the monthly rate which means that the interest rate is about 30% per annum. A home loan in India can be obtained at 10 to 11% interest rate per annum and a personal loan is about 14% per annum. Steve is paying two to three times the interest rate on his credit card. Let us say Steve bought a pair of pants for Rs.1000 and did not pay off his balance for a year. At the end of the year, the balance due on the credit card will be 30 % more so the pants now cost him Rs.1318.  In Steve’s case his balance is Rs.30, 000 so his annual interest is approximately Rs.9000.

What kinds of loans are available in the market and why do we get into it?
1.      Home Loan
This is the category of loan where people get emotional and buy as big a house as possible.  We all have a picture of our dream house.  A bigger and well-furnished house signifies wealth and is a status symbol. I understand that buying a house is important but it is imperative to take a loan that we are able to pay off.  While taking a home loan, account for things like recession, job loss and whether you have enough of an emergency fund (six to eight months of monthly expenses) stashed away. Remember; if people judge you by the size or interiors of your house, it is best to stay away from them.
2.      Education Loan / Student Loan
I have seen all the extremes in this category. People who take a loan and pay it off within the first year and those who finish their degree in their twenties and are still making payments in their late sixties. I finished my doctorate at age 27 and had a huge amount of student / education loan. I paid it off aggressively with my husband’s help. We lived on my husband’s salary and every penny I made was used to pay off the loan. As a result, my education loan was paid off in seven months. It felt like a big achievement. If you have an education loan, be aggressive about paying it off and do not add another kind of loan till one is paid off.
3.      Car Loan
A luxury item like a car should be bought if you have some savings (six to eight months of living expenses) and you should be able to pay it off in three years or less. Make sure to account for expenditure like petrol/diesel, maintenance, depreciation and insurance. If you have to buy a used car, I endorse that decision.
4.      Cell Phone Loan / Loan For Other Fancy Products
Not allowed! If you cannot pay for this outright, there is no point of taking a loan for a cell phone or a camera. One can live without this. Buy a phone or a camera you can afford even if it is dirt cheap with minimal features.
5.      Credit Card Debt
Absolutely forbidden! Please do not get me wrong. If you use a credit card responsibly to buy things online or for convenience, it is perfectly fine. However, please pay off the balance before the due date every month. To help you remember, set reminders anywhere and everywhere possible.

My Debt Mantra :
a.       Try not to think of a house/car as a status symbol. Buy small to live simply and peacefully. To practice this, I have stopped asking people to give me a tour of their house. I also discourage people from touring mine.  When people come over; the point is to spend time with each other, not look at the house.
b.      Practically evaluate your situation before taking a loan and account for the interest rate and unexpected events like a job loss.
c.       I understand that all of us have a right to education. If you  take an education loan, please be aggressive about paying it off.
d.      Before taking a loan, decide the time you will take to pay it off and stick to the target.
e.       Never miss a loan payment. You will end up paying interest on interest. To avoid forgetting; set reminders on your fridge, your wall calendar and your cell phone calendar, if it has one.
f.        Before taking any loans, one must have an emergency fund. Stash away six to eight months of your living expenses and make sure you can save some amount every month despite the loan payment.
g.       Credit card debt is evil. It is a loan at extremely high interest rates which is not worth it. If you use a credit card, pay it off on time. If you cannot remember to pay it off, do not use a credit card.  
h.      Do not give into peer pressure to buy a fancy phone or fancy jewelry. Someone will always have a “better” or “worse” gadget than you.
To sum it all up, I believe in simple living, high thinking.  A debt free life can give you a high. It is an achievement that feels better than any house, car or phone.

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