Leverage is a necessary evil in our lives. If not a housing loan, many of us have car loans and a few of us perhaps have the more expensive personal loans too.
The idea of increasing your affordability with the help of a loan sounds good until the interest repayments start to catch up. If you have more than one loan then the strain just piles up.
You may have to give up travel plans, plans around your child’s education or even a round of redoing home décor if the loan repayment itself is a big portion of your monthly outgo.
If on top of this there is an unforeseen event like job loss or an accident, it can cause a lot of financial strain.
The big loans can pull down goals
Loans should also be taken keeping in mind the ability to afford repayments not just in terms of the absolute value but rather as a proportion of your monthly income.
The big loans that form a part of most individuals’ financial lives are things like home loans or loans against property or business loans.
Their sheer size tends to take up a huge proportion of monthly income when it comes to the repayment or EMI. At the time of applying for the loan, the goal seems singular, to get the house or start the business.
However, since these are long term loans the pressure of repayment can continue for many years. In the meantime, goals shift; maybe the business does not generate enough revenue or the house you bought is no longer sufficient for your family. Pre-paying large sized loans is not easy as it requires high levels of liquidity.
At the same time continuing with these loans means you are stifling your ability to focus on newer goals that are more important.
Unforeseen outcomes can also create havoc. Large organisations have gone bankrupt without much notice, putting their employees on the spot; many of whom then struggle to repay home loans taken in more stable times. Or indeed a pandemic like event occurs and takes away the regular income that you relied on so heavily.
That’s why large-sized loans need to be thought through a lot more before signing on.
Even small loans can hinder investments
Even the smaller loans like car loans or loans taken for consumer durables or small-sized personal loans need your careful attention. Firstly, some of them – like personal loans or credit card overdrafts – are very expensive and the interest cost will drain your finances.
Secondly, it’s easy to pile on more than one small-sized loan, causing a larger than expected aggregate outflow for monthly loan repayment.
Two car loans, a washing machine, a TV and a laptop taken on a monthly EMI and a personal loan for your mother’s medical treatment, it all adds up.
The repayments will squeeze out your monthly income completely, leaving you with little else to invest towards long- or short-term goals.
While things like medical treatment do seem important enough to warrant a loan, had you not had all the other loans running, you may have had sufficient savings for treatment, alternatively, you could take on relevant insurance for that.
Small loans like this are never a necessity and very often can throttle our financial resources if we go overboard.
Loan repayment is a reality you will not be able to escape no matter what your financial circumstances are at the time.
When it comes to large sized loans, try to stick to a loan worth 40%-50% of the asset value rather than taking up a 90% loan. Excess leverage can build up fast and pull your life goals down even faster.