All of us go for loans at some point of time or other in the span of our lifetime. Some of these loans such as home loan are considered good, because it leads to creation of an appreciating asset and you also enjoy tax benefit on it. While other loans such as car loan, credit card loan etc. are considered bad, as they lead to buying a depreciating asset and may be bad for your personal finances.

In the era of consumerism, even mobile phones, TV, Refrigerator, laptops, tablets and home theatres, amongst host of other such items are all available on easy credit - either through EMI facility on credit cards or such teaser scheme floated by NBFCs. All such luring easy finance options have promoted consumerism and no wonder malls and electronic shops are seeing good footfalls. (Also Read: Would zero interest consumer loans soon be history? to know the steps taken by RBI to STOP EMI facility offered by big retail chains through tie up with banks)

But then the question is, are these easy finance options (which lure you), good for your personal finances? Well, to answer that, in most cases no! They end up damaging your financial health, as very often many get into debt-trap very quickly, leading to a financial mess.

Same is the case with one of our client who had almost all the type of loans and didn't know how to settle these in order to get out of the financial mess he was in.

Let's take his case as eye-opener for thousands of PersonalFN's readers and how we helped him to come out of this through our Personalised Financial Planning Service.
 

Personal Details
Name	Raghu (Name changed to protect privacy)
Age	32 years
Marital Status	Married
Income	Rs 75,000 per month.
Expenses (other than EMIs)	Rs 40,000 per month.

 

Personal Details

Mr. Raghu a 32 year old married individual was earning Rs 75,000 p.m. while his expenses were Rs 40,000 p.m. Please note that his expenses did not include EMI for his various loans. So he had surplus of Rs 35,000 p.m. out of which he had to service his EMIs and invest for his future financial goals.

He had the following assets and liabilities as depicted in the table below.

Assets			Liabilities
No.	Type of Assets	Amount (Rs)	Type of Loan	Outstanding Amount (Rs)	Interest Rate (%)	Pending EMIs (Months)	EMI (Rs)
1	Equity Mutual Funds	75,000	Home Loan	1,200,000	10.50%	180	13,265
2	EPF	100,000	Car Loan	200,000	11.50%	36	6,595
3	PPF	18,000	Personal Loan	150,000	14.00%	18	9,287
4	FD	30,000	Credit Card Loan 1	40,000	30.00%	12	3,899
5	Residential Flat	2,500,000	Credit Card Loan 2	50,000	36.00%	9	6,422
6	Cash in Bank	70,000	Hand Loan (Brother)	100,000	0.00%	0	-
Total		2,793,000		1,740,000			39,468

Assets...

So, you can see that Mr. Raghu had very few assets totaling to Rs 27.93 lakhs out of which Residential Flat comprises 90% of his total assets. Since he is staying in this flat, it could not be sold. His investments in EPF and PPF could not be liquidated and he is maintaining some amount of cash and Fixed Deposits (FDs) for contingency purpose. (Download our PPF Guide for FREE to know all the details about PPF)

Liabilities...

As far as liabilities are concerned, Mr. Raghu had several of them, of which Home Loan was taken for his residential flat (which he is currently self-occupying). He had also taken a personal loan for furnishing this very house and the rate of interest which he was paying on this loan is at 14% p.a. He bought a small car on loan for which he was paying interest at the rate of 11.50% p.a. His credit card loans led by his impulsive buying were carrying a worryingly high interest rate of 30.00% p.a. and 36.00% p.a. He had also taken an interest-free hand loan from his brother for the down payment of his flat which can be repaid anytime within next 3 years

And here was Raghu's Concern!

He had a surplus of just Rs 35,000 p.m. while he had total EMIs of Rs 39,468. So how does he manage his cash flows to pay-off liabilities and which liability need to be settled first.

PersonalFN recommended him to do the following:

And what did we achieve...

In next 11 months all his high interest rate liabilities were paid-off and his total EMIs came down from Rs 39,468 to Rs 19,860, leaving a surplus of Rs 15,140 p.m. (Rs. 35,000 total Surplus after all expenses but before EMIs - Rs. 19860 total EMIs) in his hands after paying all his expenses including the EMIs.

The surplus of Rs 15,140 p.m. was asked to be utilized for the following:

1. Credit Card Trap: Do not make any further impulsive buying on credit cards or otherwise.
    
2. Avoidable Expenses: Avoid unnecessary expenses such as dinning out and movies at least till the time he gets out of this financial mess.
    
3. View on Equity Mutual Funds: Equity Mutual Funds worth Rs 75,000 which had been invested in thematic and sectorial funds were asked to be redeemed. He was also asked not to further invest in such funds as these are high risk investment proposition and such funds perform only when their underlying respective sectors are doing well.
    
4. Payment of Credit Card Loan 2: First pay-off Credit Card Loan 2 of Rs 50,000 as this had the highest rate of interest of 36% p.a. out of redemption proceeds of Equity Mutual Funds.
    
5. Payment of Credit Card Loan 1: Secondly pay-off Credit Card Loan 1 of Rs 40,000 as this had the next highest rate of interest of 30% p.a. This needed to be paid out of balance of Rs 25,000 (Rs 75,000 total redemption value - Rs 50,000 paid for credit card loan 1) from redemption proceeds of Equity Mutual Funds and Rs 15,000 from Cash in Bank.
    
6. Payment of Personal Loan: Bear a higher EMI of Rs. 15,000 p.m. on Personal Loan carrying the rate of interest of 14% p.a. Increasing the EMI ensured that personal loan will be paid off within next 11 months rather than keeping it pending for 18 months (as per his earlier liability structure). By doing so, he was able to save interest for 7 months at least.
    
   1. Creating at least 3 months of Contingency Reserve.
       
   2. Accumulate and then pay off interest-free hand loan from brother.
       
   3. Investment for future financial goals.
       
7. Building a Contingency Reserve: He had around Rs 55,000 in cash in bank after paying Rs 15,000 towards Credit Card Loan 1 from Rs 70,000 in cash in bank initially. Additionally, he already holds Rs 30,000 in FD. So effectively his total contingency reserve was placed at Rs 85,000 (Rs 55,000 + Rs 30,000) but we recommended him to increase it to at least 3 months of expenses (3 months of contingency was advised since he had very limited surplus otherwise minimum of 6 months of contingency is recommended). You see, since his total expenses including EMIs was Rs 59,860, he was asked to create a total contingency reserve of Rs 1,80,000. Deficit of Rs 95,000 was to be funded from Rs 5,000 p.m. surplus starting 12^th month for next 19 months i.e. till 30 month. (Also Read: Sweep in Facility vs. Flexi Deposit, Which is better? to know how to effectively utilize your contingency reserve)
    
8. Payment of Hand Loan from Brother: Starting from 12^th month, he was asked to start a SIP of Rs 3,740 in a liquid fund for 25 months so that he will have Rs 1 lakh after 3 years from now to pay off interest free hand loan from brother. (Interest assumed in a Liquid Fund at 6.50% p.a.)
    
9. Planning for other long term financial goals: The balance surplus of Rs 6,400 from 12^th - 30^th month and Rs 11,400 from 31^st - 36^th month was recommended to be invested across equity, debt & gold (through the mutual funds) for other long term financial goals.
    

PersonalFN did not advise him to increase his EMI on home loan as he was enjoying tax benefit on both - principal as well as interest payment. Even increase in car loan EMI was not advised because he had very limited surplus, which if he were to increase his EMI would not have a left any surplus for him to invest and create wealth to meet his other financial goals.

Learning's from this case study and 5 Points to Remember while taking loans:

1. Avoid taking loans for depreciating assets.
    
2. Your total EMIs should never be more than 40% of your monthly salary. This is because in case of increase in interest rates your EMIs will be further increased which will negatively affect your cash flows.
    
3. Never go for credit card loans as the rate of interest charged on it, is the highest.
    
4. Avoid getting lured to easy finance options available through credit card EMIs or teaser schemes floated by NBFCs, as this might lead to impulsive buying.
    
5. Rate of interest charged on personal loan is high, so try to avoid it until and unless it is inevitable.

If you are also facing the same situation as Mr. Raghu and need to restructure your cash flows, then do not hesitate. Do let us know at info@personalfn.com. We would be happy to plan your finances prudently enabling you to create wealth rather be financially distressed.

This is the 1st Case of our series of 4 Financial Planning Real Life Case studies to be published on every Tuesday. Watch out for our next 3 topics on Financial Planning Real Cases:

1. How to make your Dream Home a reality
    
2. How to Secure your Child's Education & Marriage
    
3. Planning for your Golden Years
    

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Comments
t58chvppsg4@outlook.com Jan 07, 2015 You know what, I'm very much inclined to agree.
ronald.fernandes@fiapl.com Oct 23, 2013 This was really excellent.

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