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| Edited By: Deepali Sen |Source: DNA |Updated: Aug 01, 2018, 06:45 AM IST
All of us want to acquire financial freedom at the earliest. Being financially free is the ultimate financial well being one can hope to achieve. At this sweet spot, you don’t need to work for money and you are truly wealthy. Adam Smith has very aptly said, “What can be added to the happiness of a man who is in health, out of debt, and has a clear conscience”?
Being in debt gets counterproductive to the aspiration of being financially free. It is like walking uphill with a full backpack. Besides eating on one’s financial energies, the risk is that you might stay trapped in the rat race for a long time to come. Furthermore, it’s a fact that if the tenure is long (15 to 20 years), you might end up paying 80-115% of the loan amount taken as interest.
Having said that, loans are required for buying things/ items that would normally stay beyond our reach for a good number of years. And the payment of interest and principal for these loans gets funded through future receivables. Loans fill the gap between total funds needed and surplus funds available. They catalyse the process of gratification of one’s experiences on the purchase of an expensive item or a costly property.
Today we’ll explore the possible ways of reducing this sunk cost (interest payouts) on our way to being debt free. Just as the power of compounding works magically when you start investing early, similarly, the process of being loan-free can be put in fifth gear.
How does this process catch speed? It becomes possible because most of the loans operate on the principle of ‘monthly reducing’, owing to which, with every passing month the outstanding principal keeps reducing and the percentage of Equated Monthly Installments (EMI) used towards principal payment keeps increasing, thus accelerating the speed of loan reduction. Below are some of the ways which can be used for the same:
Let’s look at the above two options through illustrations. Let’s take an example of a loan of Rs 50 lakhk taken at a borrowing rate of 8% for a tenure of 20 years at an EMI of Rs 41,822. If the client decides to start prepaying a sum of Rs 1 lakh every year, he will be able to square off his outstanding loan in 14 years one month. By doing this he would only have paid an interest of Rs.33.38 lakh instead of Rs 50 lakh which he would have normally paid.
On the other hand, if the client decides to increase his EMI progressively by Rs 5,000 every year, he will be able to retire the complete loan amount in 10 years itself, thereby paying only Rs 26.44 lakh, instead of Rs 50 lakh.
A combination of the above two (prepayment and increased EMI. It can be customised as per your wallet
Shifting the balance outstanding to another home loan provider. Most banks and finance companies offer attractive rates to new customers. This option must be evaluated after considering the shifting costs (processing fees, etc.)
Asking your current home loan provider to shift the outstanding amount to a lower loan rate. This option too has to be evaluated after taking into consideration the conversion fees involved
Taking a loan for buying a roof above your head is not something to be frowned upon, but the loans procured for buying luxuries are the scariest ones. Debt can be fun at times in terms of using it as a tool to acquire things, but one can’t say the same about retiring them. Thomas Fuller’s perspective on debt may seem a little stark to many, he says, “Debt is the worst poverty”.
The writer is founder partner of Srujan Financial Advisers LLP and author of Why Greed is Great
