In last week’s article, we covered the issue of how one can fall into a ‘debt trap’, especially with regards to the usage of Credit Cards. This week, we will focus on the steps one can take to get out of this. Now if you are already in a debt trap and your bills are mounting high, the first step you need to take is a relook at the credit options you have used till now. So segment your borrowings into secured and unsecured categories. Typically, Credit Cards and Personal Loans fall under the unsecured category as there is no asset or security given against them. By virtue of the risk involved in this type of credit, banks and financial institutions usually charge a high interest rate to compensate for this risk. Generally, the interest rate for a Personal Loan ranges between 16-22% p.a., and for a Credit Card, between 36-45% p.a.
The simple graph above shows the number of months it may take to repay a debt of 38,000 with the help of various instruments (assuming 2000 is paid every month against the outstanding amount and no new credit is availed). As you can see, you can pay off your debt almost 30% faster by opting for a Loan against Fixed Deposit (FD) instead of a Credit Card. As the rate of interest for a Loan against FD is lower than that of a Credit Card, you will also pay nearly 50% lower interest. Your aim should always be to move from the highest interest rate option to the lowest interest rate option of availing credit. So let’s understand some of these options a little more in detail.
Gold Loan or Loan against Gold: With this option, you can borrow money against your gold jewellery or gold coins. This is a very quick and efficient way of effectively utilizing the assets you own. The interest rate is around 15% p.a. So if you have a high interest loan, you can refinance it with a low-cost loan.
Loan against Fixed Deposit: Everyone has a Fixed Deposit with one bank or the other. Now if you are in urgent need of money, then instead of breaking this FD or going for a costlier loan option, you can take a loan against your FD. The interest rate in such a case is generally 1.5%-2% p.a. over the FD rate. The key is that your FD continues to earn interest, so in effect your loan interest rate is only 1.5-2% p.a.
Loan against Securities:? This is another effective way to capitalize on your assets (without liquidating them) when you are looking for a new loan or looking to switch an existing loan. You may have invested in equity shares, mutual funds, LIC, etc. at some point. You can get loans of up to 50-80% of their security value.
These secure modes of financing are not only easy to avail, but also a positive way to build up your credit history. So next time you are looking for a loan, don’t forget to look at your investments first!