Being smart about debt can help the average investor save a guaranteed 3% p.m. This is a serious amount of money for people living on a day-to-day basis! It is a conscious decision that could save you a decent amount of money! So how can you do this?
The Debt Dilemma
First of all live within your means and stay away from debt. For anything that you want to buy you should be able to sell some of your own assets and pay for it. The seriously rich people do not borrow. Surely when a kid is born in the Birla family they do not look for a student loan! However borrowing is a reality for most middle class people. Some borrow for cars, homes, etc. and some others borrow for day-to-day consumption also! For what you borrow reveals how much you can postpone consumption. Not long ago a 43 year old man would do a Recurring Deposit to buy a refrigerator. An asset purchase was a big event which was eagerly awaited. The asset could be a washing machine, refrigerator, air conditioner, etc. Now buying on instalment is easy. This leads to debt. The worst (most expensive) debt that you can get is perhaps the credit card debt, and it hurts!
Let’s say you owe Rs. 10,000 on your credit card(s) and are paying 3% interest per month. The credit card companies, which of course like having a steady stream of revenue, might ask you to make a ‘minimum’ payment of Rs.500 a month. But just making a minimum payment will result in years of debt.
Assuming you pay a fixed Rs.500 each month for the next several years, how long will it take to pay off the Rs.10,000 debt? At least 10 years! Of course this is an exaggeration, but over 90 months you would have repaid a lot of the principal (only about Rs. 1370 would be remaining) You would have also paid approximately Rs.10,000 (Rs. 9967 to be precise) in interest alone. The other costs not quantified is the service tax @ 12% on all the interest! That’s a lot of money to pay for credit.
So what should you do if you already have debt?
Pay the MAXIMUM amount that you can pay. Let us say you pay Rs. 500 per month instead of paying the mandatory MINIMUM 5%. This alone will mean that in 29 months you would have paid off Rs. 14,500 – obviously Rs. 4500 as interest and you would have only Rs. 270 still outstanding as balance.
What happens instead of Rs. 500 you pay Rs. 750 per month? Well the fall is even more dramatic. By the 16th month you would have paid off the whole amount (Rs. 462 would be still outstanding) and you would have paid only Rs. 2000 as interest!
So, simply put, the credit card usage can be summed up as follows:
– Use the credit card only to transact, not to revolve credit.
– If you do use the credit allowed pay off as quickly as possible
– Even if you are paying a small amount every month, keep the AMOUNT constant, not the percentage (as the credit card communication would urge you to!)
– Once in a while pay off a big portion – say you are paying Rs. 500 per month, and in one month you have some surplus, make a big payment of say Rs. 2000. That will also bring down your outstanding amount quickly.
So get smart about debt…
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