India’s rising household debt is once again in the news. According to the latest report by the State Bank of India, the country’s household debt to GDP reached an all-time high of 37.3 percent during the financial year 2020-21. This shouldn’t be a surprise as for the last 6-7 years, household borrowings on account of home loans, vehicle loans, credit card debt and general personal loans have been growing faster than income and GDP growth.
Things became problematic in FY21 because the pandemic led to loss of jobs for many while most of those who managed to retain their jobs faced salary cuts.
And there are various estimates which suggest that millions of families in India are facing the financial dilemma where they have to choose between loan servicing and their daily family and personal expenses.
If you are one of them, don’t panic. Just like companies, it’s not unusual for individuals to find themselves in a situation where their debt is unsustainably high compared to their income (or revenues in case of business).
The best way to deal with high debt is to first reduce your interest burden, then cut the debt, and finally become debt free over a period of time. Here are 8 points to keep in mind while resolving your debt burden:
1. What’s the nature of your loan? Check whether you have taken the loan for funding consumption or to buy an asset such as a house, land or commercial property. You should worry about pure-consumption loans first such as credit card debt, bank overdraft and loans for buying consumer goods such as cars or mobile phones. These loans also come with high interest rates that can be a big burden on your cash flow.
However, if you have taken the loan for buying an asset such as a house, commercial property or land then it shouldn’t be a big worry.
You should worry about them only if the quality of assets is far worse than expected. In the worst case you can always sell the asset and repay the loan.
2. Calculate your Loan Servicing Ratio (LSR). First add all your income and cash flows, including imputed savings on house rent if you are living in the house that’s on loan. The next step is to calculate the combined monthly outgo on all your loans. Now divide your monthly income or cash flow with total monthly EMI to get LSR.
Your finances are in top health if LSR is higher than 3X; you can manage if LSR declines to 2X but it’s a cause of worry if it falls below 1.5X. If your LSR has now fallen in the red zone then think of repaying some of the most expensive loans in your portfolio.
3. Check the interest rate on your loans. The interest rate on the loans determines the servicing cost or Equated Monthly Installment (EMIs). If the EMI is high and you are finding it tough to service it due to decline in income or rise in expenses, see if your lender offers the option to reduce the interest on your loan.
This option is most common for home loans but you can also reduce the EMI on your car loan through balance transfer to other banks that offer lower interest rates. Another way to reduce EMI is to extend your loan-term or the tenure of loan
4. Talk to the bank officer. If the conventional means are not enough to alleviate your debt servicing, then have a frank discussion with the loan officer at the bank or the NBFC. In the post pandemic period, most lenders are more than willing to come out with innovative ways to lessen the financial pain such as payment deferment for reduced EMI for two years followed by accelerated payment in later years. You can choose this option to buy time and in the meantime work on growing your income. The deferment is mostly available for home loans.
5. Repay Credit Card and Consumption loans first. As discussed above pure-consumption loans carry high interest and they should be tackled first.
Repay these loans as quickly as possible by borrowing from friends or family or selling assets such as your family’s gold or silver holdings in the absence of other options.
6. Calculate your net worth. Your personal or family’s net worth—the difference between the current value of assets and debt—is the crucial number that tells you where you stand financially. Here assets include home, land, stocks and mutual fund units, the surrender value of life insurance policy, the current value of your car or two-wheeler, bank balance and FD and gold and silver in the possession of your family.
If your net worth is positive and growing faster than your financial liability then debt is not a problem for you. But if your net worth is not growing either because your assets are not growing in value or debt is growing faster, then it’s a warning sign that your financial condition is getting worse.
7. Borrow against assets. Loans against assets such as houses, land, gold jewellery, life insurance policy or even stocks and MF units are far cheaper than personal loans from banks.
Here, the top-up loans against the current home loan should be the first option followed by any loan against LIC policies and then gold loans.
8. Generate your cash flow statement. Lastly, get a grip on your cash inflow and outflow so that you are better able to manage your expenses and escape the problem of too-much debt in future. Try matching all your cash outflows with inflow every quarter if not every month. If you find it tough to do it manually then download a good app. There are now many phone apps that use your bank withdrawal and deposit and bill payment history to create a monthly cash flow statement. Use them to stay on top of your finances.
(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).