Improved credit access and rising lifestyle aspirations have encouraged many people to avail and service multiple loans. Higher debt burden not only reduces the savings ratio of individuals, any unforeseen income disruptions can lead many of them towards defaults and debt trap. Thus, borrowers having multiple loans should always aim towards optimising and reducing their debt obligations. Here are some tips on managing multiple loans simultaneously.
1. Opt for debt consolidation:
Debt consolidation allows borrowers to replace their multiple loans availed at higher interest rates with a lower number of loans at lower interest rates. As the primary objective of consolidating existing debt is to reduce the interest cost, borrowers should factor in the various fees and charges levied on the new loan(s) and the prepayment or foreclosure penalties, if any, on the existing loans while calculating their overall interest savings. Those having inadequate repayment capacity can also opt for longer tenures while availing the new loan(s) for debt consolidation.
For example, individuals burdened with credit card debt can avail personal loans for debt consolidation. The personal loans interest rates are much lower than the finance charges levied on unpaid credit card dues while the personal loan tenures can go up to 5 years, with some lenders offering longer tenures of 6 years and 7 years. These features would allow the card users to make repayments in smaller tranches in the form of EMIs as per their repayment capacity.
Similarly, existing home loan borrowers burdened should avail top-up home loans for debt consolidation. The interest rates offered on top-up home loans are usually the same or slightly higher than the interest rates of their existing home loans, which makes top up home loans the cheapest debt consolidation option for the existing home loan borrowers. Property owners having a significant amount of outstanding debt can consider loan against property to repay costlier loans.
2. Exercise balance transfer whenever feasible
Opting for a balance transfer option allows borrowers to transfer their existing loans to other lenders at lower interest rates. This helps them in reducing their overall interest cost and EMI burden. Often borrowers witness significant improvements in their credit profile and repayment capacity after availing their original loans, which may make them eligible for availing loans from other lenders at lower interest rates. Such borrowers can negotiate with their existing lenders to reduce their interest rates. In case their lenders refuse to do so, then they should transfer their existing loan to other lenders offering lower interest rates.
Existing borrowers struggling to cope with increasing EMIs due to rising interest rates can opt for balance transfer to seek longer tenures from their new lenders and thereby, reduce their EMI burden. However, doing so would increase their total interest cost.
Borrowers exercising the balance transfer option for interest cost reduction should factor in the prepayment charges, if any, charged by their existing lenders and the processing fees and other associated charges charged by their new lenders. They should exercise this option only if the savings in their interest cost significantly outweigh the costs and efforts of making the transfer.
Use your surpluses to prepay outstanding loans
Prepayment or foreclosure of outstanding loans, especially those made during the initial years of the loan tenure, can lead to significant savings in interest cost. Thus, borrowers should always aim at prepaying their loans and start with the loans charging the highest interest rate.
Borrowers should also factor in the prepayment charges, if any, before making prepayments. While the RBI regulations do not allow the lenders to charge prepayment fees on floating rate loans, lenders are free to charge prepayment charges on loans sanctioned at fixed interest rates. Thus, borrowers should opt for prepaying their fixed rate loans only if the savings made in the interest cost significantly exceeds the prepayment charges.
While redeeming their existing investments for making prepayments, borrowers should first start with the surpluses parked in fixed income instruments like fixed deposits, debt funds, etc. The upside potential of most fixed income instruments is lower than the interest rates charged on most loans. However, they should avoid utilizing their emergency fund or investments earmarked for crucial financial goals for making prepayments. Using these fund sources for prepayments may force them to avail costlier loans to tackle financial emergencies or achieve unavoidable financial goals.
Factor in your EMIs while calculating your emergency fund
Borrowers having multiple loans should factor in their existing EMIs and other loan repayment obligations while determining the size of their emergency fund. This should allow them to continue with their loan repayments during financial emergencies or income disruptions and thereby, save themselves from incurring penalties for late payment, higher interest cost and adverse impact on their credit scores. Employed individuals should include EMIs of at least six months in their emergency funds whereas self-employed individuals or those with relatively lower job certainty should include EMIs of at least 12 months.
Fetch your credit report at regular intervals
Credit reports list the various loan and credit card related activities of individuals, as reported by the lenders and credit card issuers. Based on this information, credit bureaus then calculate the credit scores of individuals. Thus, any clerical error made by the lenders or card issuers or any fraudulent activity in the loan and credit card accounts can adversely impact the credit scores of the borrowers and thereby, their future loan or credit card eligibility. The only way to reduce or deal with this risk is to fetch credit reports from all the bureaus at periodic intervals and then report the wrong information, if any, to the concerned bureau for rectification. One can either fetch his or her free credit report from each of the credit bureaus once in a year or visit online financial marketplaces to fetch his/her free credit report with monthly updates.
(An edited version of this article was printed in Financial Express)