For a large section of people, particularly in the salaried class, debt may be unavoidable, but borrowing irresponsibly can land you in trouble. An ET Wealth survey found that 15% of respondents have an EMI outgo of more than 50% of their income. Conducted in March, the survey had 2,042 respondents from across the country, age groups and income levels. The survey also showed one of five respondents have taken loans to repay existing loans in the past year -- a classic indicator of falling into a debt trap.
Debt is not a bad thing. But you need to plan properly, so that you don’t get into a debt trap
Manav Jeet, MD and CEO, Rubique
A job loss, a medical emergency, etc. can force one to borrow beyond one’s repayment capacity, says Vinod N Kulkarni, a financial counsellor. "Salaries getting delayed has also become a major factor leading people into a debt trap as they try to survive on credit cards," adds Arun Ramamurthy, founder, Credit Sudhaar. These sudden shocks can be avoided by maintaining a contingency reserve of around six months and having insurance. However, it is the slow slide into a debt trap that can prove more dangerous as it goes unnoticed till one is neck deep in it. Look out for the following red flags and take corrective steps.
EMIs exceeding 50% of income
Many people fall prey to ‘easy EMIs’, ‘discounts’, and ‘sales’. Compulsive spending can strain your finances and push you towards a debt trap. “People who can’t control themselves often end up buying things on EMIs. When you add the various EMI obligations, you may have little money left to spend on other things,” says Ranjit Punja, CEO, CreditMantri.
Almost 15% of the survey respondents use more than 50% of their income to pay EMIs -- posing a significant threat to their financial well-being. Experts say EMI outgo should be less than 50% of one’s monthly income.
32% of the respondents with an EMI outgo of more than 50% are senior citizens. For retirees living on a fixed income, this is particularly high.
EMIs are only a part of one's fixed obligations. There are several other fixed expenses -- rent, society maintenance charges, kids’ school fee, etc. “The fixed obligations-to-income ratio (FOIR) should not be more than 50%,” says Punja.
Crossing the 70% mark is an early warning that one may be heading into a debt trap”
Arun Ramamurthy, Founder, Credit Sudhaar
Close to 9% of respondents have FOIR of more than 70%. Experts say the 70% mark should not be crossesd because people need at least 30% of their monthly income to meet other expenses and save for financial goals.
20% of the respondents with FOIR of over 70% had annual income of less than Rs 12 lakh -- not surprisingly, relatively lower income groups find it hard to save.
If you often borrow money to meet regular expenses, you need to set your house in order. “If you have to borrow to meet routine expenses, you may be sliding into a debt trap,” says C S Sudheer, CEO and founder, IndianMoney.
People who fail to control expenses will end up borrowing even for routine expenses, hoping that they will pay it back. However this is a bad strategy
Vinod N Kulkarni, Financial counsellor
About 4% of the respondents borrowed more than thrice over the past year.
19% of the respondents who have borrowed at least thrice over the past year earn less than Rs 12 lakh a year, making them susceptible to debt traps.
Loan upon loan
Borrowing money to repay a loan, unless to reduce one’s interest outgo, is a worrying sign. “People usually don’t default on home and car loan EMIs, or on rent, school fees, etc. because of social pressures. Instead, they start using the credit card and try to tide over the bills by paying just the minimum due amount,” says Ramamurthy. This is why cash withdrawals and rollover of dues is high for many.
Over the past year, 21% of the respondents borrowed at least once to pay a loan.
27% of the respondents who have borrowed at least once over the past year to repay a loan are below 30. Youngsters must be cautious about this dangerous practice.
While borrowing for regular expenses to repay loans is bad, doing so with the help of a credit card is a sure way of getting oneself into trouble. Drawing cash via credit card invites a chunky cash advance fee. Annually, the interest works out to 35%-50%.
Even if you want to borrow, decide on the kind of debt. Using the credit card route should always be avoided
Manav Jeet, MD and CEO, Rubique
Some 9% of the respondents withdrew cash using credit cards over the past year.
14% of the respondents who used credit cards for cash withdrawals happen to be senior citizens. At 12%, those below 30 form the next large group.
Not clear credit card dues on time is a major red flag. Almost 21% of respondents either missed the credit card payment or rolled it over by paying just the minimum due amount over the past year. Often people don't realise how costly such rollovers can be. "Since the minimum amount payable is low, people fall into this trap. The real problem of this carry forward is the high interest rate (around 3% per month),” says Punja. If you have got into this rollover trap, getting out of it should be your top priority; postponing it will only worsen the problem. You can also utilise some investments to get out of the rollover trap. If you still cannot pay your dues in full, consider getting the card outstanding transferred to a lower-cost loan.
29% of the respondents who missed at least one credit card payment over the past year earn less than Rs 6 lakh annually.
Banks refusing loan
The survey reveals that banks have rejected loan applications of 5.4% of the respondents. “Banks rejecting your loan application is a dangerous sign, especially, if it is because of the fall in your credit score,” says Sudheer. Though credit score ranges from 300 to 900, only scores above 750 are considered good by most banks. While some NBFCs lend to people with lower credit ratings, they usually charge a higher interest rate. Check your credit score once in a while and take steps to improve it.
The credit score for individuals is like the credit rating for companies, and efforts should be made to keep it high
Manav Jeet, MD and CEO, Rubique
"Even for retirees, credit score is important because they may have to take loans in future in case of an emergency. Also, the credit score will come into play if you choose to be a co-borrower or guarantor for, say, your children's loans," says Joseph.
22% of the respondents whose loan applications were rejected last year earn less than Rs 12 lakh annually. Higher rejections in this group can be attributed to their higher FOIR and higher loan rollovers.
If you are frequently missing paying utility bills, you maybe spending beyond your means. This will impact your credit score and may keep you away from low-cost funding options. Some 3% of the respondents have missed payments at least thrice over the past year.
6% of those who missed utility bill payments at least thrice last year are below 30 -- revealing lack of awareness on its impact on credit scores.
If you decide to take a loan now and repay it when you get a fancy bonus later this year, you may be in trouble. “People always hope for the best and don’t factor in possible problems that may emerge in the future. So, borrowing based on current salary is fine, but not on expected bonus, increments, etc,” warns Jeet. People also need to distinguish between the fixed and variable components of their salaries, when calculating the EMIs they can afford.
Consider only the fixed pay as your salary and your EMI should not be more than 50% of this fixed pay
Arun Ramamurthy, Founder, Credit Sudhaar
Some 16% of survey respondents have spent money anticipating a bonus or increment.
18% of the respondents who based their expenditure on expectations of a higher future income are below 30.
Many people overestimate future salary increments. Since the base is smaller, increments are higher at the start of one’s career. So, assuming you will get similar increments till you retire, to take larger loans may not be a prudent strategy. Banks also offer loan products where the EMIs increase with time, usually after a gap of a few years. As most people take floating rate home loans, they should also be ready for sudden spikes in EMIs due to hike in interest rates. “People should factor in 20% increase in EMI due to rise in interest rates and have some contingency funds earmarked for their loan repayment also,” says Vineet Jain, co-founder and CEO, Loanstreet.
About 24% of the respondents have taken loans with rising EMI feature.
50% of the respondents with rising EMI loans fall in the 30-60 age group. Rising EMIs are not suitable for those above 45.
Impulsive shoppers end up buying non-essential items on loans. But though these loans are floated with features like ‘easy EMIs’, they come with high interest rates—18-25%. EMI offers from credit cards can also be quite expensive. “People get into the problem because most credit card companies allow one-time purchase, above a certain amount, to be converted into an EMI. Immediate loan facilities like this can force you to stretch your finances. Due to the ‘sales’, this problem (of easy EMIs) usually gets exaggerated during festive seasons,” says Punja.
Almost 25% of the survey's respondents have bought electronic gadgets on EMIs.
70% of the respondents who bought electronic goods on credit fall in the sub- RS 12 lakh annual income group.
HOW TO GET OUT OF A DEBT TRAP
Getting out of a debt trap can be a herculean task. “Once a person defaults, he gets into a vicious cycle: he cannot get cheaper loans to repay debt, his interest burden increases, and the debt pile rises,” says Ramamurthy of Credit Sudhaar. Difficult though it is, there are some steps you can take to get out of the debt mire.
Your first priority should be to get rid of high-cost loans—credit card outstanding, personal loans, etc. Since it’s quite unlikely for an investment to generate returns that can match the cost of credit card outstanding—around 40%—it makes sense to pay off the dues by cashing out investments in mutual funds, gold, etc. Taking help from one’s family is another option. “Hiding financial problems from family members is a big problem. Connect with family or close friends and try to get interest-free loans,” says Vineet Jain of Loanstreet.
Consolidating existing loans and leveraging your assets to get new loans at reasonable interest rates to settle existing expensive loans should be the next step. “As short-term loans come with higher interest compared to long-term loans, you may take long-term loan against property, top-up on your housing loan, and settle your high-cost loans,” says Jeet of Rubique. “Some NBFCs lend to people who have the ability to pay back even if their credit score is low because of a default. You may approach and negotiate with such NBFCs to grant loans at reasonable interest rates,” says Ramamurthy. Be careful though, as NBFCs usually charge higher rates.
The above mentioned steps can only save you in the short term. For a long-term solution, the best step is to reduce your expenses. “Adjusting lifestyle and living within one’s means is the only long-term solution. It may be painful, but it needs to be done,” says Joseph of Finvin Financial Planners. Start by identifying expenses that can be reduced relatively easily—taking a bus or a train instead of travelling in a car, avoiding eating out, etc. “Though expense reduction measures will vary for people, the reduction has to be substantial,” says Punja of Credit Mantri.
The other long-term solution is to work towards increasing one’s income. “Increasing family income—non-working partner can start taking tuitions, online jobs, etc, even full-time jobs, if possible—to help the family get out of the debt trap permanently,” says Joseph. More importantly, you should make sure that your current job is protected. “As people tend to become inefficient at work due to debt trap worries, their career growth stops and in the worst case scenario, they may end up losing the job, which only compounds the problem,” says Jain.
Narendra Nathan
TNNDebt is not a bad thing. But you need to plan properly, so that you don’t get into a debt trap
Manav Jeet, MD and CEO, RubiqueEMIs exceeding 50% of income
Many people fall prey to ‘easy EMIs’, ‘discounts’, and ‘sales’. Compulsive spending can strain your finances and push you towards a debt trap. “People who can’t control themselves often end up buying things on EMIs. When you add the various EMI obligations, you may have little money left to spend on other things,” says Ranjit Punja, CEO, CreditMantri.
Almost 15% of the survey respondents use more than 50% of their income to pay EMIs -- posing a significant threat to their financial well-being. Experts say EMI outgo should be less than 50% of one’s monthly income.
32% of the respondents with an EMI outgo of more than 50% are senior citizens. For retirees living on a fixed income, this is particularly high.
Fixed expenses more than 70% of income
EMIs are only a part of one's fixed obligations. There are several other fixed expenses -- rent, society maintenance charges, kids’ school fee, etc. “The fixed obligations-to-income ratio (FOIR) should not be more than 50%,” says Punja.
Crossing the 70% mark is an early warning that one may be heading into a debt trap”
Arun Ramamurthy, Founder, Credit Sudhaar20% of the respondents with FOIR of over 70% had annual income of less than Rs 12 lakh -- not surprisingly, relatively lower income groups find it hard to save.
Borrowing to clear regular expenses
If you often borrow money to meet regular expenses, you need to set your house in order. “If you have to borrow to meet routine expenses, you may be sliding into a debt trap,” says C S Sudheer, CEO and founder, IndianMoney.
People who fail to control expenses will end up borrowing even for routine expenses, hoping that they will pay it back. However this is a bad strategy
Vinod N Kulkarni, Financial counsellor19% of the respondents who have borrowed at least thrice over the past year earn less than Rs 12 lakh a year, making them susceptible to debt traps.
Loan upon loan
Borrowing money to repay a loan, unless to reduce one’s interest outgo, is a worrying sign. “People usually don’t default on home and car loan EMIs, or on rent, school fees, etc. because of social pressures. Instead, they start using the credit card and try to tide over the bills by paying just the minimum due amount,” says Ramamurthy. This is why cash withdrawals and rollover of dues is high for many.
Over the past year, 21% of the respondents borrowed at least once to pay a loan.
27% of the respondents who have borrowed at least once over the past year to repay a loan are below 30. Youngsters must be cautious about this dangerous practice.
Using credit card route for cash
While borrowing for regular expenses to repay loans is bad, doing so with the help of a credit card is a sure way of getting oneself into trouble. Drawing cash via credit card invites a chunky cash advance fee. Annually, the interest works out to 35%-50%.
Even if you want to borrow, decide on the kind of debt. Using the credit card route should always be avoided
Manav Jeet, MD and CEO, Rubique14% of the respondents who used credit cards for cash withdrawals happen to be senior citizens. At 12%, those below 30 form the next large group.
Not clearing credit card dues
Not clear credit card dues on time is a major red flag. Almost 21% of respondents either missed the credit card payment or rolled it over by paying just the minimum due amount over the past year. Often people don't realise how costly such rollovers can be. "Since the minimum amount payable is low, people fall into this trap. The real problem of this carry forward is the high interest rate (around 3% per month),” says Punja. If you have got into this rollover trap, getting out of it should be your top priority; postponing it will only worsen the problem. You can also utilise some investments to get out of the rollover trap. If you still cannot pay your dues in full, consider getting the card outstanding transferred to a lower-cost loan.
29% of the respondents who missed at least one credit card payment over the past year earn less than Rs 6 lakh annually.
Banks refusing loan
The survey reveals that banks have rejected loan applications of 5.4% of the respondents. “Banks rejecting your loan application is a dangerous sign, especially, if it is because of the fall in your credit score,” says Sudheer. Though credit score ranges from 300 to 900, only scores above 750 are considered good by most banks. While some NBFCs lend to people with lower credit ratings, they usually charge a higher interest rate. Check your credit score once in a while and take steps to improve it.
The credit score for individuals is like the credit rating for companies, and efforts should be made to keep it high
Manav Jeet, MD and CEO, Rubique22% of the respondents whose loan applications were rejected last year earn less than Rs 12 lakh annually. Higher rejections in this group can be attributed to their higher FOIR and higher loan rollovers.
Not paying utility bills on time
If you are frequently missing paying utility bills, you maybe spending beyond your means. This will impact your credit score and may keep you away from low-cost funding options. Some 3% of the respondents have missed payments at least thrice over the past year.
6% of those who missed utility bill payments at least thrice last year are below 30 -- revealing lack of awareness on its impact on credit scores.
Borrowing based on future income
If you decide to take a loan now and repay it when you get a fancy bonus later this year, you may be in trouble. “People always hope for the best and don’t factor in possible problems that may emerge in the future. So, borrowing based on current salary is fine, but not on expected bonus, increments, etc,” warns Jeet. People also need to distinguish between the fixed and variable components of their salaries, when calculating the EMIs they can afford.
Consider only the fixed pay as your salary and your EMI should not be more than 50% of this fixed pay
Arun Ramamurthy, Founder, Credit Sudhaar18% of the respondents who based their expenditure on expectations of a higher future income are below 30.
Loans with increasing EMIs
Many people overestimate future salary increments. Since the base is smaller, increments are higher at the start of one’s career. So, assuming you will get similar increments till you retire, to take larger loans may not be a prudent strategy. Banks also offer loan products where the EMIs increase with time, usually after a gap of a few years. As most people take floating rate home loans, they should also be ready for sudden spikes in EMIs due to hike in interest rates. “People should factor in 20% increase in EMI due to rise in interest rates and have some contingency funds earmarked for their loan repayment also,” says Vineet Jain, co-founder and CEO, Loanstreet.
About 24% of the respondents have taken loans with rising EMI feature.
50% of the respondents with rising EMI loans fall in the 30-60 age group. Rising EMIs are not suitable for those above 45.
Falling for ‘easy EMIs’
Impulsive shoppers end up buying non-essential items on loans. But though these loans are floated with features like ‘easy EMIs’, they come with high interest rates—18-25%. EMI offers from credit cards can also be quite expensive. “People get into the problem because most credit card companies allow one-time purchase, above a certain amount, to be converted into an EMI. Immediate loan facilities like this can force you to stretch your finances. Due to the ‘sales’, this problem (of easy EMIs) usually gets exaggerated during festive seasons,” says Punja.
Almost 25% of the survey's respondents have bought electronic gadgets on EMIs.
70% of the respondents who bought electronic goods on credit fall in the sub- RS 12 lakh annual income group.
Data analysis by Sameer Bhardwaj
HOW TO GET OUT OF A DEBT TRAP
Getting out of a debt trap can be a herculean task. “Once a person defaults, he gets into a vicious cycle: he cannot get cheaper loans to repay debt, his interest burden increases, and the debt pile rises,” says Ramamurthy of Credit Sudhaar. Difficult though it is, there are some steps you can take to get out of the debt mire.
Your first priority should be to get rid of high-cost loans—credit card outstanding, personal loans, etc. Since it’s quite unlikely for an investment to generate returns that can match the cost of credit card outstanding—around 40%—it makes sense to pay off the dues by cashing out investments in mutual funds, gold, etc. Taking help from one’s family is another option. “Hiding financial problems from family members is a big problem. Connect with family or close friends and try to get interest-free loans,” says Vineet Jain of Loanstreet.
Consolidating existing loans and leveraging your assets to get new loans at reasonable interest rates to settle existing expensive loans should be the next step. “As short-term loans come with higher interest compared to long-term loans, you may take long-term loan against property, top-up on your housing loan, and settle your high-cost loans,” says Jeet of Rubique. “Some NBFCs lend to people who have the ability to pay back even if their credit score is low because of a default. You may approach and negotiate with such NBFCs to grant loans at reasonable interest rates,” says Ramamurthy. Be careful though, as NBFCs usually charge higher rates.
The above mentioned steps can only save you in the short term. For a long-term solution, the best step is to reduce your expenses. “Adjusting lifestyle and living within one’s means is the only long-term solution. It may be painful, but it needs to be done,” says Joseph of Finvin Financial Planners. Start by identifying expenses that can be reduced relatively easily—taking a bus or a train instead of travelling in a car, avoiding eating out, etc. “Though expense reduction measures will vary for people, the reduction has to be substantial,” says Punja of Credit Mantri.
The other long-term solution is to work towards increasing one’s income. “Increasing family income—non-working partner can start taking tuitions, online jobs, etc, even full-time jobs, if possible—to help the family get out of the debt trap permanently,” says Joseph. More importantly, you should make sure that your current job is protected. “As people tend to become inefficient at work due to debt trap worries, their career growth stops and in the worst case scenario, they may end up losing the job, which only compounds the problem,” says Jain.
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