This I-Day, chart your own path to Freedom from Debt

Debt used to be a four-letter word in India. Those were the days when our grandparents saved every penny they earned, lived within their means, stood in ration queues to get milk and grains, and considered debt as a shameful thing, to be avoided at any cost.

Flash forward to 21st century and this four-letter word has almost become a necessity. Everyone seems to be exposed to some or the other kind of debt. In fact, an average urban mass middle class person typically has four-five kinds of debts in her kitty. The usual culprits are home loan, car loan, educational loan, some personal loan and our favourite - credit card dues.

But, there is a very thin line between having a debt to service and being in a debt trap. Most of us don’t even realise that we are already in a debt trap. This independence day, go through this story, find out if you are in or heading towards a debt trap, and take the eight steps to recovery given below to obtain freedom from debt.

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R-ecovery: Realise you are in debt.

[caption id=“attachment_418970” align=“alignleft” width=“380”]  The first step in getting freedom form debt is realising you are in a debt trap.[/caption]

The first step in getting freedom form debt is realising you are in a debt trap. How do you know? It’s simple. If you have more month left at the end of your salary instead of more salary at the end of the month, you probably are in a debt trap. If you have dues pending and recovery agents are calling you at odd hours, reminding about overdue payments, you are in a deeper debt trap. If more than 50 percent of your monthly income goes towards servicing your EMIs on various loans, you are close to being in a debt trap.

Even if more than 35 percent of your monthly income goes towards servicing debt dues you are half-way there. Check your financial status against these parameters. Being in denial is not the answer if you truly want to get freedom from debt.

R-E-covery: Educate yourself about various types of debts.

If you have read so far, you have already taken the first step to educate yourself about debt. Typically, there are two kinds of debts, the healthy debt and the unhealthy kind, a.k.a. good and bad debt. A debt taken to fund an appreciating asset, like a home loan, is an example of healthy or good debt. After all, in the years to come the value of your home can only increase (but not always, as US homeowners realised in 2008). Likewise, a debt taken to fund a depreciating asset is an unhealthy one. For instance, a 40 grand iPad bought on a credit card is unhealthy debt - unless you can repay it in one or two months. Ideally, in your total debt, the larger portion should be the good kind of debt and the lesser portion of the bad kind of debt.

Re-C-overy: Collect all debt (documents) at one place.

The next step is to collect all your debt-related documents at one place, so you get to see the whole picture. Which means, gather your home loan documents, personal loan documents, current utility bills and like together. Then you will need to segregate these into two sets. First, with documents related to all your debts (home, car, credits cards and like), and the second set with documents related to current bills, current dues and expenses. Like mobile bill, internet charges, electricity bill, etc. In short, current living expenses should never end up as debt.

Rec-O-very: Order of hierarchy or priority.

The next step is to calculate the total debt you owe. Then split it into two parts, the immediate and others. Those debts, which if you don’t pay immediately will get in the way of life, fall under the first option. So, get current bills out of the way first. This also includes EMIs towards mortgage loans and loans against gold. This also includes the minimum amount due on your credit card. Once you’ve paid off the debt of necessary evils, you can now look into the other debts.

Now arrange the other debts in order of hierarchy- begin with the most expensive debt (highest interest rate) and put the rest in a descending order of cost. Pay off all the minimum amount due on all debts apart from the debt where you are charged the highest rate of interest. Pay as much extra as possible (over and above minimum due) towards the most expensive debt. Then centre on the debt with the next highest interest rate, and so on. More often than not, credit card is the most expensive debt, where you pay as much as 30-45 percent as interest per annum. Pay as much as possible over and above the minimum amount. Look for balance transfer offers on your credit card; this way the rate falls down by up 1.5 percent per month. You could also look into taking a personal loan or loan against gold to pay off the credit card debt. These loans charge a lower rate (12-18 percent) of interest than what credit card charges.

Reco-V-ery: Voice your concerns.

If you are unable to handle the debt issue on your own or simply need help to manage your financial situation, doing it on your own may not be the best option. Voice your concerns and issues to professionals instead. There are credit counselling agencies like Abhay Credit Counselling Agency and ICICI Bank’s Disha Credit Counselling Agency, which provide free counselling to those struggling with debt. If you do not want to work with a credit counsellor, we suggest you avail yourself of the services of a Certified Financial Planner. They will not only help you with a strategy to come out of debt but also help you set clear financial goals and a path-map to achieve the same.

Recov-E-ry: Estimate Exigency Funds.

Even as you get serious about getting out of debt, ensure you do not ignore the unforeseen eventualities of life. Make sure, apart from servicing your current debts and aggressively paying a part of your most expensive debts, to set aside some funds for exigencies. Ideally, you should keep six months’ monthly expenses aside for the same. If six months is too much, at least have three months’ expenses kept aside, in a savings bank account or a liquid fund. So, that way, you won’t need to take on more debt in case of an emergency. Instead, just tap into the emergency fund.

Recover-Y: ‘Yucks" is the word for any future debt.

The last thing to do is avoid any future debt. This is the most importer step. Once you start coming out of debt, your mind will start playing tricks and maddening consumerism will fuel the need to impulse-shop. Be aware of this need and say “Yucks” to any future debt.

India got her independence through a long freedom struggle. Freedom from debt won’t be anything less than a struggle. So, take these necessary steps and set a goal to get freedom from debt by 15 August 2013.

Happy Independence Day!