The power of debt is tremendous. On one hand, it can help you achieve your goals. On the other, it can destroy you.
Unfortunately for Amane, a 42-year old college lecturer who is married and has a child, his loans did him more harm than good. He earns Rs 19,000 per month and is in deep debt, today.
Wealth chronicles Amane's route to debt and suggests a way out.
November 2005: He took a personal loan of Rs 1,50,000, to furnish a new house he was about to acquire.
December 2005: He took a home loan of Rs 4,87,679 to buy a property in Pune, where he now lives with his family.
September 2006: He took a motorcycle loan of Rs 50,000 and bought a new bike.
July 2007: Amane took a personal loan of Rs 5, 00,000 to buy shares, and gave power of attorney to a brokerage firm, to invest his money as they saw fit. When the stock market crashed, he lost all his savings and was left with no savings.
September 2007: He took a personal loan of Rs 4,60,000 (secured against his home), to pay off the remaining Equated Monthly Installments (EMIs) on his personal loan of Rs 1, 50,000, thereby closing the loan. He also utilised it to pay EMIs on other loans.
Loan watch
Not surprisingly, Amane is unable to pay the EMI of Rs 15,080, which obviously, did not go down well with the bank. It’s been six months since he paid his last installment, and the bank is threatening him, so he clears pending dues.
Top mistakes
The personal loan of Rs 5, 00,000 to invest in stocks was uncalled for, considering that he was already paying off three EMIs. In fact, he should have used the loan of Rs 4, 60,000 to prepay his other loans and bring down the EMI amount rather than pay more EMIs.
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Tough decisions
Amane has choices but none that are pleasant. Director, VSK Financial Consultancy Services, Yogin Sabnis advices him.
- First, Amane could sell his motorcycle and close the motorcycle loan.
- Next, he could opt to stay in a rented house, and sell of his property (worth Rs 25,00,000, now). He will be able to get rid of all his loans, and he may even be left with some surplus.
- He must invest the surplus amount equally, between fixed income instruments and diversified equity instruments.
Life insurance, yet?
Should Amane consider buying an insurance policy despite his financial situation? Yes. "It's important for him to buy a term policy in his name after he has paid off his loans. After all, he must be worried sick and that's not good for his health. And there’s his family to think of," explains Sabnis.
Mantras for borrowers
1. According to financial planners, the EMI amount should not exceed 30 to 35 per cent of your monthly income. In Amane's case, it was way over 100 per cent!
2. Amane should have taken a home improvement loan instead of a personal loan. The interest on a home improvement loan is 13 to 15 per cent. The interest on a personal loan is between 13 to 30 per cent.
3. Remember the maxim: Do not borrow to invest. Amane borrowed from a bank to speculate and that landed him in trouble.
4. Power of attorney must not be given to anyone. Amane blindly trusted the brokerage firm and gave them the authority to invest his money. Unfortunately for him, they lost all his money, and worse still, he has no recourse.
Moral of the story
Though some purchases merit borrowing, know where to draw the line. Get your priorities, right and you will always be ‘indebted’ to yourself for this!
Have you borrowed more than you can afford? Check now
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