A debt-free life usually offers more opportunities and possibilities, but then there is also the temptation to use low interest rates to build up wealth during such times.
The Covid-19 pandemic has forced many of us to reconsider our finances.
With uncertainty about jobs and wage cuts affecting monthly household budgets, the question always arises of whether to continue funding retirement plans or to reduce debt first.
A debt-free life usually offers more opportunities and possibilities, but then there is also the temptation to use low interest rates to build up wealth during such times. So where do you walk the fine line and how should you make financial decisions that will make you happy in the long term?
We consider both scenarios:
Pay off loans
Prioritizing debt settlement as opposed to saving for retirement depends on several factors, such as:
“The DTI ratio is defined as the total monthly debt payments divided by the monthly gross income. If a person has a DTI rate of 20 percent or less, they are considered financially stable and can choose to reserve tips for retirement. Central banks define a DTI rate of 40 percent or more as a financial distress situation in which the worker is required to use his tip to pay off loans. If a different decision is made, the continued 40 percent DTI may affect its ability to borrow, ”said Vijay Valecha, Century Financial’s chief investment officer (CIO).
A person’s age, coupled with their current retirement provision, is also a decisive factor in deciding whether or not to pay off loans. “A younger person may choose to continue to accumulate debt because he / she has more human capital to pay off debt in the future and wants to save something. While an older employee should work to ensure that they can live stress-free in the future, ”added Valecha.
Another important factor is the type of debt and the interest rate charged on it. “Pay off the most expensive debts first instead of trying to reduce the number of loans. Also, check the cost of early payment. Know if there are penalties associated with early foreclosure so that total costs are measured correctly, ”said Vishal Dhawan, Certified Financial Planner and Chief Executive Officer (CEO) of Plan Ahead.
So what debts need to be paid off first?
Credit card debt must always be paid first, especially if you only pay the minimum amount each month. An outstanding amount of Dh 10,000 may take more than a decade to repay the loan and you will pay the bank or financial institution about 2.7 times the original amount.
Second, don’t look down on smaller loans first and keep the big one for later. An honest assessment of which loan to keep should be based on the calculated interest rate. “You should pay off your credit card fees and personal loans first. Secured loans like home loans and auto loans can wait. When prepaying a loan, individuals often overlook the costs involved, such as: B. Foreclosure Fees. It may be tempting to close a high yield personal loan due to a sudden influx of funds, but the early settlement fees incurred must be considered before making such decisions. If cash flows allow, borrowers should try to split the prepayment or exclude high-priced, unsecured loans. Secured loans, especially home loans, can be paid in EMI (equal monthly installments) over the long term as they are generally low cost loans, ”Valecha said.
Invest in yourself
Think about taking on debt isn’t always a bad move, especially when it means investing in yourself.
Its usefulness depends on the benefits you get from it. “Whether it’s getting a college degree, buying a home or buying a car, the final factor of whether the debt you are taking out is good or bad is based on the question, will this debt repay me more than I will? have deposited? ? A simple rule is that if the loan increases your net worth or has future worth, then it is good debt. If it doesn’t and you don’t have cash to pay for it, it is bad debt, ”Valecha said.
The king of all debts is a mortgage.
“Investors need to be wise and mortgage a property that is likely to increase in value every year. For example, if you buy a house for Dh2 million and it increases in value by four percent every year, the house will be worth Dh4.38 million when your 20 year mortgage is paid off (more than double the investment made) . This is quality fault. In addition to home loans, student loans are also considered good debt as they improve the ability to have a well-paying career in the future, ”he added.
Conversely, car and payday loans, as well as credit card debt, are components of bad debt. Plastic debt can ruin financial health, and interest rates are a killer.
Additionally, there is the hidden fee with card loans that naïve investors are unfamiliar with. Car loans may not have the highest interest rate, but the value of the vehicle is rapidly depreciating and therefore is considered a bad debt unless the vehicle is a necessity and not a luxury.
The bottom line is, if an investor is a mile away from retirement and has low-interest debt to pay off, he or she can put their money into a monthly systematic investment plan (SIP) in the stock markets that will generate high returns. The idea is to leverage the time value of longer term investments as well as the ability to take risks while they can afford it.
– suneeti@khaleejtimes.com
