Did you know that your EMI-to-income ratio is an important factor determining the approval of a new loan you apply for? Generally, if the total EMIs you are paying is more than 50 percent of your monthly income, your loan application may be rejected.
Most importantly, keeping the total amount of your EMIs at a manageable rate prevents you from acquiring new debts.
Managing EMIs
These days, it is easy to fall into the temptation of taking loans for different purchases. Be it a house, car, two-wheeler, or even a washing machine – Equated Monthly Instalments are available for almost every kind of purchase. So when should you stop?
Lenders may say that your EMI-to-income ratio should not be over 50 percent, but that doesn’t mean you should borrow on till you reach this 50 percent cap. You need to consider your expenses towards credit card bills, household expenditure, income tax, energy bills, family requirements, and savings and investments. Consider how much money you would be able to spare after these regular expenses.
Experts suggest that your EMI should not exceed 25-30 percent of your income. If it is over 50 percent, you are already in a crisis and need to rearrange your finances immediately.
Borrow wisely
Debt is not always a bad thing. It helps you stay focused and consistent. However, too much of anything is bad. If you are in the habit of taking a loan for everything, you are sure to get into financial trouble.
- It is advisable to match your debts to your income. If you are spending more than what you earn or expect to earn in the near future, then you are on the way to financial doom.
- Borrow money only for essential things – vehicle, house, furniture, household appliances – and not for fun or expendable items. For example, avoid taking personal loan for a vacation to Bhutan. Do not borrow money from a friend to throw a grand party after purchasing a new bike.
- It is not a good idea to take loans in order to invest. If your investments are in the stock market, it will be unpredictable; if you are investing in a long-term plan, you will have to repay your loan before the investment gives results.
Deciding tenure of loans
The basic principle of loans is the longer the repayment tenure, the more money you’ll end up paying in total.
- If you do not have many debts and can afford a higher EMI, choose that over a longer repayment term. For example, if you have to choose between paying Rs. 67,000 for 10 years or Rs. 45,000 for 30 years, the earlier one is advisable if you can afford it. In the above example, for 10 years you’ll end up paying around Rs. 80 lakh, while for 30 years you’ll be shelling out over Rs. 1.60 crore.
- If you get a windfall or bonus while you are on loan, try to make partial payments of the principal amount, or foreclose the loan. This will help reduce the total money you pay to the lender.
Keeping your expenses within your income plans is a best practice of money management. Accumulating EMIs without considering regular expenses, savings and emergency funds is not advisable. Repay your loans regularly to prevent accumulation of debt.
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