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Effective financial planning includes managing debt


Many smart individuals resort to financial planning to handle their finances better. They make a budget, invest towards their goals, and plan their taxes. Yet, despite everything their financial plan could fall short.

The reason is not hard to understand. While all other activities of financial planning are undertaken, managing debt burden is often ignored. This ignorance unbalances even a good financial plan, and makes it go awry. This is why it is crucial to have effective financial management. To enjoy the effective financial planning, managing your debt is important. Do you know how you can do so? If you don’t here are some tips for you -

How to manage your debt

• Identify your liabilities
The first and the foremost task is to know how much you owe and to whom. Until and unless you know your actual liabilities you cannot make a plan to repay them. So, work out the details of your debts, their interest rate, the outstanding amount and the outstanding tenure. Once you know how much you owe at any given time, you can proceed to service your debt.

• Repay on time
One of the most important ways to manage your loans is to repay them on time. Every loan has a monthly repayment date. Stick by this date to avoid late payment fees and charges. Paying on time is also good for your credit score which is negatively impacted in case of a default. To ensure timely repayments you can opt for direct ECS with your bank. Your bank account would be automatically debited at a particular date for every instalment due. Your repayment would be done and you would be spared the burden of remembering the date.

• Avoid bad loans
Personal loans and credit card loans, though easily available, are not a very good choice. It is because of two reasons. Firstly, they have very high interest rates. Secondly, they are unsecured loans which put a negative impact on your credit score. Try and avoid these unsecured loans. Instead, opt for secured loans like loan against property or loan against your investments. These loans are secured against your assets. They have a lower interest outgo and are also good for your credit score.

• Prepayment is not always good
Though prepayment reduces your loan liability, it is not always a good choice. In many cases prepayment involves a charge. Even in those instances where prepayments are free, you incur an opportunity cost. The money you spend on prepaying your debt if invested elsewhere might yield you higher returns than the interest you are paying. Let’s understand it with an example –
Suppose you have Rs.50, 000 in surplus funds. You can either prepay your home loan or invest this money in a good scheme. Your home loan’s interest rate is, say, 9% per annum while the investment avenue promises you 12% returns. If you prepay the loan you would be saving the 9% interest outgo on Rs.50, 000. However, you would be losing the 12% return which you can earn if the money is invested. Since the investment return is better than the debt interest rate, prepayment is not a good option.
So, always weigh the scales before prepaying your debt. Try and direct your additional funds to lucrative investment avenues instead to earn higher returns.

• EMI v/s monthly income ratio
Ideally, your debt EMIs should not exceed 15% to 20% of your monthly income. You should have at least 80% to 90% of your earned income in hand (after paying off the debt instalment) to meet your lifestyle costs and for saving. If EMIs are more than 20% of your income, it might create a cashflow problem. So, when you are choosing loans, ensure that the EMIs don’t put a strain on your income.

• Use your loans for tax planning
Home loans and education loans give you tax benefits. The interest you pay on home loans is exempted under Section 24 while the interest paid on education loan is exempted under Section 80EE. Since your loans give you tax relief, use the benefits if you have these loans.

Managing your debt is an important aspect of the financial planning process. For an effective financial management and to reap the benefits of financial planning in business, don’t forget to include debt management into the planning process.

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