Stay away from Loans – 7 Tips

There are many people who like to live on the edge and not care about savings or financial planning. Of course there is nothing wrong in taking liberty or indulging once in a while, because you need to also spend or enjoy what you have earned.

However, that does not mean you have to empty your bank account by every month end. Most people like to use loans or credit facilities to satisfy their wants and indulgences, which actually impacts their future finances. So being judicious with loans or credit cards is important if you don’t want to get in to a debt trap.

Are all loans bad?

A young MBA graduate, Ankit was placed in a good company and was happy getting his first salary. He was well settled in his job for more than a year.

Although he had a bank account and some savings to start with he avoided all loans and credit cards for two reasons – one – he didn’t require them in the first place and secondly he heard lot of stories about loans, credit card bills, interest charges, etc., which were not encouraging. Should you also ignore or avoid all loans and credit cards? Not at all.

Loans and credit facilities are definitely useful provided you use them selectively and wisely. Try to avoid or minimize loans/credit for consumption needs – like say personal loans (for any purpose), credit cards, car loans, etc. If you are already stuck in loans, try to pay off those loans which attract high amount of interest.

For instance credit cards and personal loans attract high interest. Credit cards charge anywhere between 30-45% p.a. while the interest rate on personal loans ranges between 18-25% p.a. These have to be retired first so that your monthly interest burden gets minimized.

However housing loan is still worthwhile because it is used for buying an asset which saves rents (or creates income) and also provides capital appreciation. Similarly education loan, which is used for improving your qualification and status is also worthwhile. However, you can also opt for other loans depending on your needs on a selective basis without hurting your monthly budget. For more on this you can read my article “Good, bad and ugly loans”.

Now our focus will be on how to avoid or stay away from loans as far as possible.

Ways to stay away from loans (as far as possible)

First, let me clarify my position. I’m not telling you to stay away from loans all the time. You will still require loans for housing, education and personal spending, so abstaining from loans totally is not a good idea. Except for these genuine needs, I would frankly advice you to stay away from loans assuming you are a normal salaried individual with a regular income source.

Some of the points here may not apply to people who are in business or self-employed. Some of the ways that I would suggest are:-

1. Avoid Impulsive Purchases

Joel , a young BPO Executive in Bangalore recently shifted to a rented studio apartment decided to buy a few things and set up his home. He started buying some furniture, a computer, etc. Joel wanted to buy a television, so he discussed with a few friends, who advised him about the latest LCD and Plasma TVs that are hot in the market.

After a week, Joel bought one LCD TV for Rs.60,000 using his credit card. The LCD TV came with a complete suite of accessories, which gave a home-theatre kind of experience on his credit card.

Everything went well for Joel for a month. One fine day the credit card bill comes and he pays partially. The very next month the bill comes with some interest and charges. Now Joel got jittery and decided to sell his LCD TV and so as to settle his credit card issue.

When he put an offer for sale, a few people came in most people were willing to pay only pittance for the TV. The best offer was for Rs.20,000. But his bill was over Rs.50,000. Joel decided to sell for Rs.20,000 and settle the issue once for all.After another 3 months the same brand new LCD TV is selling at Rs.40,000.

The Lesson: Never try to jump after something new. Most electronic goods are expensive at the beginning, and as it gets mass-produced prices will come down drastically.

2. Postpone your Purchase (Don’t rush to buy something new)

This is one boring advice you often hear from older people. In the olden days this was the norm, but today in the age of “buy now pay later” era we are not patient enough to wait.

There are many people like Joel who want to buy the latest mobile phone or LCD TV. If you think you are not among them, just think again. Most people have the need to have something trendy or new to show off.

Lets take the example of Apple iPhone 4S, which has a starting price of Rs.42,000. The models with better features are priced even higher at close to Rs.58,000.

Do you really want to rush and buy to prove that you are smart? Well, wait for a few months and your foolishness will clearly show up. Of course if you can afford it and really need it, you won’t feel the pinch so much.

Moving away from electronic goods, many people have this fancy for new things such as:-

Movies – First Day First Show
Buying the latest branded wear
The latest car or SUV
New Mutual fund scheme
IPOs

Remember that all that glitters is not gold, and all that is new is not necessarily the best.

3. Pay cash wherever possible instead of loading your credit card

The old fashioned way of paying cash still works well. If you are buying something just ask two important questions:

Do I really need it?
Would I buy if I had to pay by cash?

If your answer is yes to both questions, then you can buy. If your answer to second question only is ‘No’ probably you can postpone for a while. But if you decide to pay by credit card just make sure that you can pay off the bill next month.

For most daily expenses I would recommend paying cash so that you don’t have a big laundry list in your credit card statement. For example all your groceries (except bulk purchases), fuel expenses, restaurant bills, some utility payments, etc can be paid by cash.

Of course several expenses such as salary to maid, newspaper bill, payment to milk vendor, etc are done through cash only.

4. Avoid Carrying Credit Card (This is for people who are addictive only)

I’m not against carrying or using credit card, and this suggestion is not for normal people who use credit card selectively. This is for people who are addictive.

This can be a small exercise or challenge to people who were splurging on credit card so far. This is a kind of exercise to help you reorient or rehabilitate yourself so that you know how to spend judiciously, and this works well when you pay by cash.

Some people have also admitted that physiologically they have a sense of responsibility when they pay by cash. This may not be true for all, however, to make sure that your credit card bills are light so that you don’t burn a hole in your pocket every month after paying high interest costs.

5. Use Accumulated Savings to buy something

This is another old fashioned technique like postponing which most youngsters hate to do. Most people who have good salaries try to rush to buy all things at one go instead of saving for it.

A married couple Mr. and Mrs.Khurana have a combined income of Rs.80,000 per month. They decided to move to a separate rented home like most other young working couples.

But they decided that they will start their life new and afresh and this enthusiasm led them to purchase everything new right from their footwear to the furniture.

They bought all brand new sofas, TV, kitchen appliances, two sets of cots/beds, a computer, etc. They got a good offer from one hypermarket which gave them a basket of products for Rs.75,000 (after discounts). In addition, they also bought some more new furniture and decorative stuff as well as other things for Rs.1.25 lakhs.

On both occasions they used their individual credit cards for purchases which were almost reaching the credit limits. Then the couple also bought a car for Rs.3.5 lakhs financed by a car loan.

In the next month their bills carried interest and heavy charges. They paid a small amount and things were fine. After another month one of the cards reached its full credit limit and the card could not be used anymore.

Moreover, there was another car loan EMI for Rs.9000 per month which was pinching them in addition to rising petrol prices. Almost 80% of their salary went towards EMIs, and whatever was left did not last till month end, leading them to further swipe their credit cards or cut down on essentials like food, clothing, etc. Is this the kind of new life they dreamt about?

The Lesson: Don’t buy everything at one go. Instead stagger your purchases.

The Khuranas should have purchased things gradually over 2-3 months instead of doing it in one go. This means you need to prioritize expenses and spend accordingly.

6. Take stock of what you have

The Khurana couple we discussed above also had some furniture, kitchen appliances, TV, etc. in their previous accommodation, which could have been used partially to cut down fresh purchases. Alas, most people seem to hate things that are old, and this provides marketers a good way to entice people in to useless spending.

Most people who go for shopping don’t have a list of things to buy, and the result is you end up with unwanted stuff – additional set of shoes, furniture, stationery, etc. which you don’t need. Instead you forget to buy what you need – like say a good trouser, toiletries, groceries, etc.

7. Build Assets to become Financially Free

If you want o become financially free, you need to build assets not liabilities. If you add liabilities then you are only building EMIs and boosting your expenses which drag down your finances.

If you want to buy assets, buy them with your own money, except in the case of real estate or housing where you have housing loans to finance the purchase.

For example if you buy a stock of a good company you get some income in the form of dividend and your capital appreciates, when stock prices rise. Robert Kiyosaki, the author of “Rich Dad Poor Dad” series defines an Asset as “something that puts money in your pocket”. So you have to buy assets if you want to become financially sound and successful.

So going by this definition Assets do not include cars, furniture, electronic goods, appliances, branded wear, etc because these are purely expenses or things that lose value. If you want to come out of the ‘rat race’ and achieve financial freedom, stop accumulating liabilities, instead build and accumulate assets.

Some good assets include equity or real estate which earn you some income as well as appreciate in value overtime. So the lesson here is to eliminate or minimize liabilities and build more assets that will generate stable income overtime and also appreciate in value. This strategy will gradually help you build a safety net for your retirement and help you become financially stable and free.