Money Week – How to manage long term debts
In keeping with the theme of Money Week, being ‘financial resilience’, we looked at smart ways to use your credit cards in the first part of this series.
The concept of resilience is relevant across all aspects of your financial make up – whether that be managing your debt or saving for your future. We all take on debt in various forms. By far, our largest debt at some point in our lives will be the loan we take out for the purchase of a property. Of course, you may at times have to depend on a personal loan as well to make some big ticket purchases like a car. All debt needs to be repaid and most of them come at a cost. Typically, that cost is the interest charged on the amount you borrow. Debt also comes with conditions around when you should pay back and how much, along with the consequences of you not paying that as per those terms.
Which all makes it look bad to have debt. But the fact is, having debt in itself is not bad. In fact, there is something called smart debt, for example – taking a loan on the basis that you are able to apply that money you borrow to an initiative that earns you an amount bigger than what you have to pay back with interest. But, a lot of the debt you see around you, is pretty dumb. Why?
Because the money borrowed goes towards things that get consumed in time (like a car or a handbag or a shoe etc.), not towards things that generate more money.
Debt – long term (home loans, consumer loans etc.)
Home loans and consumer loans allow you to borrow money from a financial institution to give you access to money which can be put towards the settlement of the property or item you purchase.
The condition is that you pay back the amount you have borrowed in small amounts over a number of months and years. In order for you to access that money, the institution charges interest on the amount you borrow. The entity lending you the money will typically also want some guarantee over your ability to pay (called ‘collateral’). In the case of a home loan, the property itself happens to be the collateral.
Being resilient means being able to repay the amount agreed to the lender in the regular time intervals agreed. So the key here is to ensure that you have enough cash flow to satisfy those repayment commitments as and when they fall. It doesn’t matter how wealthy you are or how many other houses or other assets you own. The only question is – can you generate enough cash at these regular intervals? Either from a salary or an income or by selling your assets (god forbid!).
A big part of being financial resilient is being smart about how you mange your money. Do you know if you have the smartest and cheapest loans possible? There is a wide variation in how much interest you are charged on your loan.
The PocketWise team