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''Hard work is like a staircase and luck is like a lift. Lift may fail but staircase is sure to take you to the top'' -- unknown

To be fearful when others are greedy, and be greedy when others are fearful -- warren Buffet

I am better investor because I am businessman,better businessman because I am no investor. -- Warren Buffet

6/27/2007

Buy now, pay later & repent at leisure



We live in the world of "buy now, pay later". Almost every consumer product can be bought for an equated monthly installment (EMI) which is a fraction of the maximum retail price (MRP).

Every real-estate developer and car dealer has a financing arrangement tied-up upfront

few years ago, banks stringently refused you a loan even if you had a regular monthly income. Today, you are inundated with calls on your mobile phone for personal loans and loans against property.

Easy access to loans lures us into buying a fancier car, own an elegant plasma television or travel to an exotic holiday destination in Europe, but in the process we fail to take stock of our financial health and may get trapped into overborrowing

When you spend now and pay later, you are leveraging your future income. There are a couple of questions to consider: First, what if for some reason the future income stops.

How will you service your EMIs if you loose your job? In the instance of untimely death of the borrower, the dependents will be liable to square off the loan.

It may be worthwhile to take adequate insurance to cover the liability. Secondly, what are you borrowing for? Is it to acquire an appreciating asset such as a house to live in or promoting your career by going for higher education or is to buy a luxury item and support an extravagant lifestyle?

Consumer debt is a dangerous spiral and very hard to get out of.

How much can you afford to borrow, is the question everyone faces. Typically, not more than 25% of your income should go towards servicing your loans.

Here, I have assumed that 50% of your income goes towards your expenses and other liabilities and 25% towards saving for your medium- to long-term goals.



To illustrate, if your take home salary is Rs 60,000 per month, your EMI payments should not exceed Rs 15,000. As you might expect, there are exceptions to the 25% rule.

If you are in an early stage of your career and residing with parents, not having significant monthly expenses and probably having a rather small take-home paycheck, a larger monthly payment is justified.


If one spouse earns far more than the other, the one with the smaller paycheck can easily break the rule. If you have a home loan going, 30-35% of your income can go towards servicing loan EMIs.

The higher amount is permissible because a house is your biggest life spend and an appreciating asset.


Choosing the tenure of the loan wisely is equally important. A higher tenure enables you to reduce the EMI but it raises the interest burden.

The greater the EMI you are willing to pay, the greater your interest savings. Say, you take a loan of Rs 5 lakh at 15% interest per annum for five years, you will pay over Rs 2 lakh as interest.


If you can manage to reduce the tenure from five years to three, you can save about Rs 89,000 which is 43% of your interest. See the Chart for incremental interest cost for every additional year.

Lastly, check whether you have pre-payment and step-up options.


As your salary increases over the years or you get a bonus, you may like to pay the whole or a part of the balance loan and save your expenses on interest.

You may like to reduce the tenure and increase your EMI.

(The writer is CEO, Cornerstone Wealth Management)

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