Loans are like an addiction; they tempt you to aspire for things that you otherwise can’t afford under normal circumstances. And as you go on relying on loans to cater to your aspirations, you do a great harm to your finances, often leaving yourself at great risk of falling in a debt trap and creating a financial disaster unless you are conscious of what you can handle and what you can’t.
But then, loans are also a great way to meet your dreams. How many people would have been able to own their dream homes had there been no home loans? But one has to be practical and judicious about your financial status and be very disciplined when one goes for a loan.
The first thumb rule before going for a loan is to have a good idea about one’s monthly cash flow and how much one can manage to save. Remember, the loan will make available the money you need today, but you will have to repay it from tomorrow and that too with a hefty additional cost in the form of rate of interest.
Often one tries to rely on what one could save last month and calculate how much loan to take on the basis of that. That’s not how you should calculate your loan affordability. The best way to find it out is to check the details of your income and expenditure for a much longer duration, of say three to four months, to assess basic factors such as how much money you can really save and how large a repayment installment you can afford, what are extra expenditure you can cut and what are the sudden additional expenditure that can arise in your life. If you do that arithmetic honestly, you are halfway through.
Once you have done that, look for the best deal on the loan you require. You can compare rates of interest, processing fee and other conditions like pre-payment penalty to choose the option that suits you best.
Yet, before signing on the dotted line to go for a loan, calculate your monthly outgo towards EMI payments and see to it that you don’t exhaust all your monthly savings just paying the EMI. It would be best if you can manage to save at least three months’ EMIs in a bank account before you actually go for a loan.
Once you have availed the loan and started repaying it through monthly installments, the next target should be to try and save regularly to target an early repayment of the loan. If you can manage to do this, you will end up saving a huge additional outgo in the form of interest cost, which then can be accumulated into a huge corpus over a period.