- Prepare your debt list
- Prioritize your debts
- Repay debts with higher interest rates
- Plan, follow, repeat
- Avoid falling into this trap again
Equated Monthly Instalments (EMIs) have changed people’s spending habits. They have altered consumer behavior, as people now tend to spend more than before, sometimes way beyond their means. With credit facilities available instantly, anyone can now purchase items and postpone payments to a later date. Therefore, many are relying on loans and financing facilities to make purchases.
The primary reason for this is because it delays the immediate and heavy outflow of cash and gives the purchaser time to repay the amount. This usually creates a debt trap which a person only realizes when the total outflows of all the EMIs combined eat into a significant portion of their income and affects their budget.
Being debt-free then becomes their biggest dream. If expenses are properly planned, then a debt trap can be easily avoided. If you want to know how to become debt-free in 5 years, then here is a guide that shows the best way to empower yourself if you are stuck in a debt trap
This is the first step in our recommended list of debt-free tips. Before making the effort to become debt-free, you must know the amount of debt that you have piled up. Start with preparing a list that covers all your existing debts. This will tell you how deep you are into this trap. Don't just list down the amounts. Instead, prepare a detailed list of the purpose of the loan, the amount of the EMI and its due date and the rate of interest charged. This will give you a clear picture and will help you set a priority list.
Debts are not always bad. A debt taken to create an asset is considered good and benefits you in the long run. Home loans, loans for education or business, etc., facilitate your growth. However, if you are in debt because of credit card bills or personal loans taken for any non-beneficial purpose, it would be better to pay them at the earliest.
You will even notice that interest rates on such debts are enormous when compared to standard loans. Credit card companies usually charge 20%-30% interest per annum. Even personal loans are expensive. Therefore, set a priority list of all your existing debts. If you are debt-free and want to continue this way, then prioritize your demands and purchases. If you are planning to make a purchase using EMI facilities, then only buy what is necessary. Your present purchases affect your future finances due to EMIs. This way, you can always keep yourself debt-free.
This is where your quest to become debt-free begins. Higher interest rates mean higher EMIs. Therefore, it is preferable to repay such debts on a priority basis to reduce the EMI burden significantly. These will mainly include outstanding credit card bills, personal loans, and other unsecured arrangements. Save for a while and start prepaying these loans.
The amount prepaid will be deducted from the principal outstanding, and this will either reduce the tenure of the remaining loan or reduce the EMI amount. However, do not use your entire savings to prepay your loan. Always maintain emergency funds, otherwise, you may need to borrow again in case of an emergency, making you fall into the debt trap again. You can allocate a fixed portion of your income to this prepayment.
For example, let's imagine you have an outstanding credit card bill of Rs. 1,50,000, an outstanding personal loan of Rs. 80,000 and a home loan of Rs. 25,00,000. Here, you shall start with the repayment of credit card bills on priority. This is because the interest rate would be highest on credit card loans compared to your other debts, and secondly, it will affect your credit score.
Once you get relieved of credit card debt, you will start feeling relaxed and debt-free. Your EMIs will reduce, and now you can focus on personal loans, which is the second-highest interest-bearing loan. A home loan that you have taken is to create an asset, and the interest rates on a home loan are usually lower, although the EMI may be huge primarily because the amount of loan sanctioned is huge. It is one of the most affordable loans. Therefore, you can keep it later on your priority list.
Keep repeating the process of prepayment till all your existing high-interest-bearing loans are paid, and you become debt-free. Starting off will be difficult and slow, as other than your EMIs, you will also have to allocate your income towards prepayment. You can reduce your unnecessary expenditure to save more. Gradually, you will be able to save more because of the reduction in EMIs, and this process will become quicker over time. Soon you will be at a stage where most of your existing loans would have been paid off, and you will feel debt-free
Once you start realizing that you are getting out of this debt trap, be very careful not to fall into it again by forming an opinion that you can borrow now as you are debt-free. Unfortunately, this attitude drives people into a second debt trap. Instead, focus on investments. Think about how to grow your investments which will help increase your net worth and income.
Your spending habits will decide the fate of your finances. After earning, people tend to first spend on unnecessary items, other monthly expenses and then save whatever is left. This usually leads to zero savings for most people and the creation of a debt trap. Instead, you should crave to save and invest first. Make a rule to allocate at least one-third of your income to savings and investment. Then spend on what is essential. You can use the remaining amount for your other demands and luxury items. Soon, you will gradually notice a steep increase in your assets, which will also increase your income and net worth.
It's not impossible to become debt-free. Many people are so overwhelmed by debt, they feel there is no way out. But, if you follow the tips listed above, you can easily become debt-free in a few years. If you are young, then it is best to avoid debt as much as possible.
When you take on debt in the initial years of your life, say in your 20s, then you spend your 30s and 40s paying EMIs to become debt-free. By the time you reach your late 40s and become debt-free, you realize that the majority of your work-life is already over, and in a few years, you would be retiring. This realization at a later stage of life is painful for many. Therefore, do your best to remain debt-free through sound financial investments and proper planning.