Make your loans light weight

This article by Nisary Mahesh, Founder HerMoneyTalks is originally published in The Hindu Businessline

 

Loans are indispensable today to achieve our lifestyle goals — be it a dream home or a pricey gadget. While we are sailing through a “Buy Now Pay Later” culture, managing our loans effectively is the key for financial fitness.

For an average Indian, EMIs are a significant portion of their monthly expenses, and reducing this can free up money for savings and thereby more investments.

Let’s explore some practical strategies to help you reduce the interest burden of your loans.

Choose the right one

Selecting the apt loan type is the first step in minimising your interest burden. As we know, secured loans like home or car loan, come with lower interest rates compared with unsecured loans like personal loan or credit card loan.

Here are some smarter choices to make:

Home loan top-up v/s personal loan: If looking for funds for a wedding expense or a business need, you need not rely on a costly personal loan always. If you already have a home loan, a top up of the same can be a cost-effective way to raise funds. To compare, a home loan top up of ₹5 lakh at 7.5 per cent for a period of three years saves you ₹37,878, over the same amount at a personal loan of 12 per cent.

Gold loan instead of a business loan: Gold loans typically have lower interest rates than unsecured business loans. If you choose a gold loan of ₹10 lakh at 10 per cent over a business loan at 15 per cent, it saves you ₹1.52 lakh over five years.

Loan against fixed deposits / mutual funds / insurance: Instead of breaking your FDs or mutual funds, consider a loan against them. Interest rates would be 2-3 per cent above the FD rate, which are lower than personal loans. Loan against insurance policy is another option you can try over a personal loan.

Fixed or floating?

Fixed interest rates remain constant throughout the loan tenure, whereas floating rates fluctuate based on market conditions.

Many home loan customers have a perception that taking a fixed rate loan is a better choice than floating. Whenever there’s a rate revision, they tend to switch between the two.

But remember, constant switches may cost you more than the small benefit you may gain out of it.

Tranche EMI option

Home loans for under construction property are disbursed in tranches. Until the full disbursement is over, you will be paying interest for the disbursed amount, which is called Pre EMI.

Choosing tranche EMI option allows you to start EMI for the loan amount, even before disbursement. Even if you started EMI while loan not fully disbursed, it is still a good option as it saves you from paying Pre-EMI which doesn’t consist of principal portion, and you may save a considerable amount.

But all banks may not offer this, as they are losing the advantage of Pre EMIs.

Loan repayment

If suppose the EMI of a loan is heavy on your pocket in your early years of career, or during a down time, you can opt for step-up or step-down repayment options. In step-up, you will start with lower EMIs that increase over time. It is ideal for those expecting higher future income. Step-down is ideal as choice during a down time like a job loss.

By matching your repayment capacity with income trends, you reduce financial stress and manage interest costs better.

Loan management

Consolidation: If you have multiple loans with varying interest rates, consolidating them into a single low-cost loan can simplify payments and reduce your overall interest burden. However, ensure that the consolidated loan’s total cost including processing fee is lower than what you would pay on your existing loans.

Pre-payments: Allocating annual bonuses or windfall gains toward loan prepayments can help you reduce the overall cost of borrowing. As interest is calculated on the outstanding principal amount, reducing the principal early in the loan tenure can save you money.

Shorter tenure: While longer loan tenures may lower your monthly EMIs, they increase the total interest payable. A 15-year home loan at 8 per cent interest will incur less total interest than a 25-year loan at the same rate. Use online EMI calculators to strike the right balance between affordability and interest savings.

Negotiate: Banks may offer better terms to retain loyal customers. You can negotiate for lower interest rates, especially if your credit score is high (750+). By renegotiating a personal loan of ₹5 lakh from 13 per cent to 11 per cent, you save ₹30,296 over five years.

Leverage tax benefits: Certain loans, such as home loans and education loans, offer tax benefits (old tax regime) that can indirectly reduce your burden. Under Section 80C and Section 24 of the Income Tax Act, you can claim deductions for principal repayment and interest paid on home loans. Similarly, Section 80E allows tax benefits for the interest paid on education loans.

Balance transfer: Shifting your existing loan to another lender offering a lower interest rate also may be a good idea sometimes.

Reducing the interest burden on loans requires a proactive and informed approach. Evaluate your existing loans, compare available options and align repayment strategies with your financial goals.