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Debt and Debt Management

By Hema Moryani

Basics of Debt

They are contracts in which one party lends money to another at certain pre determined terms

Rate of Interest

Tenure

Interest payment Schedule

They may be referred to as gilts, bonds, debentures

Basics

In times of economic boom

Salaries rise

Spending rises

Lifestyle changes

This gives rise to personal borrowings

Loan by individual – housing loan, personal loan, education loan, credit card

Type of borrowing

Good Borrowing

The generate an asset

Leads to income

Bad Borrowing

Splurge on luxury that cannot be afforded

Depreciating assets

Higher interest rates

Types of loan

Secured loans

Mortgages

Any other asset, gold, securities

Unsecured loans

Personal borrowing

Credit cards

What leads towards a debt trap

Excessive borrowings

High interest rate borrowings

Borrowing of money at higher rate to pay off a low rate loan

To improve liquidity

Debt consolidation

Borrow at a cheaper rate to pay of higher interest bearing loan

Consolidate all unsecured loan against a secured loan

Debt Consolidation

To give up several loans and take one loan

Ascertain the period you would like to repay the loan

Rate of interest

Amount to be repaid according to the available liquidity to avoid defaults.

Debt Settlement or Debt Relief

Debt settlement or Debt relief or bankruptcy

Helps in reduction in the interest rates or

Settlement worked up to payoff a large lump sum

Debt forbearance

Where the lender gives up the interest portion but the principal repayment is maintained

Debt Restructuring

Refers to the reallocation of resources or changes in the terms of the contract

General Restructuring

Works to the benefit of both the debtor and the creditor

Would normally refer to the extension of the repayment or lowering of interest rate

Debt Structuring

General Restructuring

Existing debt is replaced by a new debt

Where the interest rates may be altered

The tenure may be postponed

Debt Restructuring

Troubled Restructuring

The creditor(lender) incurs some loss

He may have to give the accumulated interest amount

Dip in the collateral security

Conversion of loan to equity

Debt To Income Ratio (DIR)

Monthly Income Rs.100000

Type of loan

EMI

Percentage

Ideal limits

Personal loan

5000

5%

Vehicle loan

15000

15%

Credit card

20000

20%

Total

40000

Percentage(Excluding Mortgage)

40%

40%

30-35%

Mortgage EMI

25000

25.5%

20-25%

Total Percentage

65%

65%

50-60 %

Debt To Expense Ratio

Income Rs.1,00,000

Household Expense

25000

Education Expenses

7500

Personal expense

5000

Other expense (petrol etc)

5000

Total expenses

42500

Percentage to income

42.5%

Using the DIR Method

Target those debts for faster pay offs that have a biggest impact on the income ratios

Take the mortgage loan and try to re- structure the loan

Review the budget in the areas to reduce spending and to create savings

Dealing with credit cards

Debt Snowball Method

List all the credit cards

CARD 1

CARD 2

CARD 3

TOTAL

AMOUNT

5000

7000

13000

20000

MINIMUM PAYMENT

560

370

700

1630

Other payments

10870

Remember !!

Borrowing cost money

Never borrow what you cannot repay

Never borrow for luxuries when you cannot afford necessities

Prioritize your borrowing

Reserve some borrowing capacity for emergencies