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Juggling several loans? Here’s how you must balance your debt repayment and liquidity

Always start with the loan charging the highest interest rate. Have an emergency fund that includes your EMI dues, too.

June 14, 2021 / 09:10 AM IST

Loans act as a gateway to fulfilling various financial goals, which otherwise cannot be met through your own resources. These include owning our dream house, purchasing a new vehicle or financing a child's higher education. Due to increased credit access, many individuals end up simultaneously servicing multiple loans.

Here are some tips for managing multiple loans:

Prepay outstanding loans whenever you have surplus funds

Prepayment or foreclosure of outstanding loans can lead to significant savings in interest cost, especially if made during the initial years of the loan tenure. Hence, those having financial surpluses should always aim to make loan prepayments. While choosing among multiple loans for prepayment, always start with the one charging the highest interest rate.

However, before making prepayments, factor in the applicable prepayment charges, if any, levied by the lender. Although the RBI bars lenders from levying prepayment fees on floating rate loans, lenders may levy prepayment charges on loans availed at fixed interest rates. Opt to prepay only if savings in the overall interest cost significantly exceeds the charges, if any, levied on making prepayments.

Also, avoid utilizing your emergency fund or investments earmarked for crucial financial goals for prepaying or foreclosing loans. Doing so can force you to avail costlier loans to tackle financial exigencies or achieve crucial financial goals. While choosing among asset classes of your existing investments for prepaying loans, first redeem the surpluses parked in fixed income instruments such as fixed deposits, and short-term debt funds. The returns generated by fixed income instruments generally tend to be lower than the interest rates charged on most loans.

Opt for balance transfer whenever feasible

The Balance transfer option allows you to transfer your existing loan to another lender at a lower interest rate and thereby reduce your overall interest cost and EMI burden. Hence, existing borrowers having significant residual loan tenure should periodically compare the interest rates charged on existing loans with those offered by other lenders.

The best way to do so is to visit online financial marketplaces to check out loan offers available from various prospective lenders based on your monthly income, credit score, job profile and other facets of your credit profile.

If the interest rates offered by other lenders can lead to significant savings in your loan’s overall interest cost, then the first step should be to approach your existing lender to reduce your interest rate. If the existing lender refuses to do so, then go ahead with transfer of existing loan to the lender offering the lowest interest rate. However, before exercising the balance transfer option, ensure to factor in the applicable prepayment charges, if any, charged by the existing lender and processing fee and other associated charges levied by the new lender. Opt for the balance transfer option only if the overall savings significantly outweighs the associated costs.

Also read | Home loan transfer: Factors to consider before shifting lenders 

Include loan EMIs in your emergency fund

The primary purpose of maintaining an adequate emergency fund is to tackle unforeseen financial exigencies or income disruptions due to sudden job loss, severe illness, disability or other adverse life events. Ideally, an adequate emergency fund should be sufficient enough to meet your unavoidable monthly expenses for at least six months. Hence, those repaying existing loans should include their existing EMIs and other loan repayment obligations equivalent to at least six months in their emergency fund. This would allow them to repay their EMIs and other loan obligations during such period of exigencies and thereby save themselves from incurring late payment penalties, increased interest cost and adverse impact on credit scores due to delay or defaults in loan repayments.

Periodically review your credit report

Your credit report lists various loan and credit card related activities as reported by the lenders and credit card issuers. Bureaus then calculate your credit score on the basis of the listed information. Hence, any clerical error made by the lenders or fraudulent activity in your loan and credit card accounts can adversely impact your credit score. The only way to mitigate this risk is to periodically fetch your credit report from the bureaus and report the incorrect information, if any, to the concerned bureau or lender for rectification.

Reviewing your credit report at periodic intervals, ideally at least once in three months, can also get you customized and pre-approved loans, balance transfer and credit card offers based on your credit score and other facets of your credit profile.
Naveen Kukreja is CEO and Co-founder,
first published: Jun 14, 2021 09:10 am