Worried about Your Debt Burden? You Need the Right Financial Education

Dec 18, 2020

Listen to Worried about Your Debt Burden? You Need the Right Financial Education

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All of us work hard to live a life that is financially stable. Being vigilant while managing your hard-earned money is essential if you wish to maintain sound financial health. It can be a precarious situation if one's finances get out of one's control.

Amidst the coronavirus pandemic, many of us have faced different financial challenges. For instance, a friend had financial difficulty when he received a 50% pay cut due to the pandemic.

He had a home loan and had paid his EMIs diligently earlier... but could not manage the EMIs with other expenses after the pay cut. Additionally, he had maxed out his credit cards, which eventually led him into a debt overhang.

Now if he had prepared a contingency plan, it would have prevented the debt burden he's currently facing.

You see, there's nothing wrong with taking a loan or having a debt, as some debts can be beneficial (as in it can help with taxation or to accomplish certain goals sooner), but only if you are comfortably within your means to repay it.

However, if you are struggling to make debt payments or your debt payments are higher than your net monthly income, it's a sure sign that you are challenged with a debt burden.

This scenario will also lead to other financial problems, such as failure to save or invest, missing regular utility bill payments, compromises on lifestyle, etc. Besides, taking on any extra debt just to stay afloat will create a greater debt overhang and adversely affect your financial health.

Therefore, to evaluate your debt situation, you should consider the Debt-to-income ratio as it is one of the vital financial health indicators.

Debt-to-income ratio is the percentage of your net monthly income that goes towards paying your monthly debt payments. It is calculated as:

​Now, to compute your total monthly debt payments, sum up credit card dues, EMI on your personal loan, car loan, home loan, education loan, and any other debt obligations.

Similarly, to compute the net monthly income take into consideration, the actual income earned every month from various other sources like salary, business or profession, house property, capital gains, interest or dividend, etc.

For instance, if you have a total monthly debt payments of Rs 36,000/- and you receive net monthly income of Rs 1,00,000/-. It reveals that your total monthly debt obligations are 36% towards your net monthly income.

Typically, the 43% debt-to-income ratio is the highest ratio you as a borrower may have and still qualify for loans in the future. But as a thumb rule, to ensure smooth servicing of loans/debt, make it a point that the deb-to-income ratio is not more than 40%. Of course, there is no "Perfect" Debt-to-income ratio, the lower it gets the better it is for you.

Now that you have an idea on how to calculate your Debt-to-Income ratio, you should also understand why it is important to assess this.

Computing Debt-to-Income ratio will assist you in determining your current debt obligations towards the income you earn. And, it will give you a better perspective on managing your debt to avoid any credit score complications. A high Debt-to-Income ratio will have a negative impact on your credit score.

In addition, it helps you realize that debt payments limit the amount of money you can initiate for other things, such as maintaining an emergency fund, saving, and investing. Moreover, it hampers any other envisioned financial goals you have planned to achieve.

Debt-to-Income ratio is seen as a measure to understand a borrower's debt repayment capacity as per their net monthly income.

Accordingly, the lending institutions/Banks check an applicant's financial fitness by verifying their credit score and existing credit utilization ratio to understand how well they are handling their current debt obligations before approving and lending funds to any borrower.

Based on that, lenders get access to your financial prudence and creditworthiness, which helps them in decision-making. However, if any borrower holds a Debt-to-Income ratio of more than 50%, the chances of receiving a loan are very low. Plus, it won't be the best deal even if you get the loan.

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Maintaining your debt at a manageable level is one of the foundations of good financial health.

So, what can you do to keep debt from impacting the quality of your financial health?

First, make an effort to reshape your Debt-to-Income ratio by reducing it further.

Here are steps you could follow:

  1. Avoid taking on additional credit or debt that may put you in a debt overhang situation.

  2. Repay your existing loans on time

  3. Try to increase the repayment amount if possible as such extra payments lower your overall debt amount quicker.

  4. Consider paying off or reducing the dues on your credit cards.

  5. Engage in debt restructuring with your current lender or refinance debt from another lender by making a balance transfer for a lower interest rate.

  6. Recalculate your debt-to-income ratio timely to see if you're making progress. It can help you stay motivated to keep your debt manageable.

  7. Increase your net monthly income by additional source of income - Renting out second house property, creating a side business, negotiating for salary hike, monetising your hobbies, etc.

  8. Adopt the concept of delayed gratification. This will give you more time to save and make a larger lump sum payment rather than increasing debt.

The lack of financial knowledge or limited financial awareness is one of the reasons many people create debt burdens.

Essentially, financial literacy equips you with the right knowledge and skills that enable an individual to know how to utilise their hard-earned money effectively, make sound financial choices, and avoid falling in any debt trap.

Understanding the value of money is a major part of financial education and some money management skills will help you to reduce debt obligations.

Being financially conscious will protect you and your family from major pitfalls. You see, individuals with limited or lack of financial education end up paying higher interest on loans and higher transaction fees. They succumb to convenience of taking instant app-based loans on high interest for minor requirements and, eventually, fall into a debt trap.

Therefore, take meticulous efforts to empower yourself with the weapon of knowledge!

If you are financially educated, you can also give your family members the financial guidance they need to overcome their debt burden if any and to help them make sound financial decisions.

PersonalFN's latest special initiative, the "Certified Family Guardian", offers you an exclusive opportunity to learn from the finer nuances of money management. Organised into eight modules with 24 extensive videos, the "Certified Family Guardian" will help you with all the relevant tools and learning modules needed to get better at money management. These modules will show you how to prevent a debt burden.

It also offers host of other benefits to help you make informed investment decisions. Read here for complete details

If you wish to improve your and your family's financial health and focus on building a debt-free financial future- enrol for "Certified Family Guardian" course today!

Warm Regards,
Mitali Dhoke
Content Writer

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