There are times when you need a little extra money in life, either to build a house or to meet the expenses of your child's higher education. At such times, a loan comes in handy. But it may also occasionally happen that your finances improve faster than you had expected and allow you to pay off a large part of your debt early. Clearing loans faster helps you in minimising interest charges on the rest loan amount. But it is also true that you can be penalised for early payment.
There are also cases where loan tenures have extended till retirement and lenders have harassed borrowers for missed EMIs. If you feel stressed because of the outstanding payments, here are a few strategies that you should follow in paying debt smartly.
Repay high-interest loans early
Identify the loans that need to be tackled first, such as credit card and personal loans. Pay the maximum amount you can by putting yourself in a situation where you default on payment of other loans. This strategy helps you minimise overall interest paid on all loans. There are some loans that offer tax benefits, bringing down the actual cost of that loan (education and home loans).
As income rises, increase repayments
This is one way of clearing your debts faster. If your income rises by, say, 8 percent, then you can easily increase the EMIs by 5 percent. Through a 5 percent increase in EMIs, you can end a 20-year loan in just 12 years, saving a huge amount in interest charges.
Convert to EMIs
Credit card bills can burn up a whole in your wallet if you spend recklessly. Though they give you interest-free credit for almost 50 days, if you regularly roll over the dues, the interest accrued could go as high as 35 percent a year. If you are finding it difficult to pay your credit card dues, ask your lender to convert the outstanding amount into easy instalments. Be careful to not miss any EMI then.
If your loan situation has turned really bad, you can use your investment in a life insurance policy to repay the debt and get some breathing space. Investment instruments like life insurance and PPF offer the investor to borrow against the balance from the third financial year of investment.
Make lifestyle changes
You must acknowledge that some of the loan burden on you could be because of the expenses that you could have avoided and used the saved money to repay debts. It's not late to cut down on luxuries and those unnecessary expenses. Avoid regular movie shows, dining out and weekend parties.
The prepayment penalty
If you pay your loan earlier than specified in the agreement, the lender may levy a penalty. This is because the lender loses the expected interest on a loan if it is paid early. Read the agreement carefully. If you are confident of paying the loan early, look for a lender without a prepayment clause.