Should I clear some chunk of my debt with the extra cash I have? or Is it beneficial to put money to work in investments that will build a nest egg? This is one trick question that never tends to allow any rest to the mind of every borrower. Clearly, both actions are very important. In this post, I will try to highlight things that one should consider before making a decision to invest. I will be emphasizing the priority as well as the importance of repaying loans.

Let’s go by some common types of debts

Some of the most common debts include borrowing to purchase an expensive item such as a car or a home. Paying for education or unplanned medical expenses are also common debts. However, the type of debt many people struggle with is credit card debt and personal loans. Let’s go over these types of debt and look to pay off the costliest loan first and not the fattest one in terms of the EMI outflow – in order to reduce the interest cost burden.

1. Credit Card or Personal Loans

Credit cards increase spending power, simplify shopping, and give us easy access to funds in times of emergency. However, skipping credit card payments or simply paying the minimum amount will attract a hefty interest rate, which can escalate into a sizeable debt over time. The same goes for Personal loans, if one is not able to repay the monthly installment, then it will multiply your debt over time.

Credit Card or Personal loans are very high interest loans and one should get rid of them as soon as possible.

2. Car or Appliance Loans

Nowadays, many of us opt for car or appliance EMI loans. The rationale behind it is to avoid spending one’s emergency funds in one transaction. The interest rates can be tricky and high for such loans. Also, the value of the entity we buy with these loans generally declines over time. A general suggestion would be, repay your EMIs with a shorter repayment schedule while saving some of your income regularly. A few approaches that one can take are listed below.

  • Choose a repayment schedule as short as possible.
  • Choose No cost EMI for appliance purchase.
  • Pre-pay a chunk or lump sum on accumulation of savings.

3. Education Loans

Education in today’s world is ironically getting expensive, forcing debt free people under the pile of debt. Higher education demands higher fees, leaving no option for people to draw huge loans. Banks provide a moratorium period in case of education loan for repayment of principal. However, banks charge interest during this period, causing the pileup. The interest component of the loan is fully exempt from tax, allowing us to repay other high cost loans mentioned above on priority. Therefore, we should try to not make full use of moratorium and start repayment as quickly as possible.

4. Medical Loans

Only unseen circumstances can force us to opt for medical loans in time of our needs. One should always be equipped with appropriate Health or Medical insurance to avoid such situations. While planning to repay the medical loan one should also consider the post-treatment expenses and take appropriate steps to clear dues.

5. Housing Loan

If you have taken a home loan, you can claim a deduction of up to Rs 1.5 lakh a year for the interest paid, while the principal amount repaid up to Rs 1 lakh qualifies for deduction under Section 80C. In fact, you can claim the full interest outgo for a house that is not self-occupied. In case of prepayment, this benefit gets reduced. So, one needs to plan his tax savings and get benefitted while planning to pre-pay housing loans.

Opportunity Cost

The above analysis does not apply strictly if the only debt you have taken is a home loan. In such a situation, on landing a windfall, instead of rushing to prepay the loan, first weigh all the options open to you.

Chances are that the same money would earn you a decent sum if you invest it. So, if you find an investment option that is yielding a return of, say, 12-14% annually, it’s a better use of your money than prepaying a home loan for which the interest rate is around 10% a year.

Debt-Free Lifestyle

For many people like me getting out of debt would be a welcome relief. There’s anxiety in owing money. Knowing you’re expected to pay big EMIs can be unsettling, especially if your budget is tight. When you are debt-free you won’t have to worry about making debt payments.

A debt-free lifestyle lets you choose what you want to do with your money. More importantly, the extra money you save by paying off your debt is to be put it into investments. More appropriate investments mean worrying less about losing a job, or even better retire early!

Peace out!