Base founder Hena Mehta on taking out a loan is a good idea

A few years ago, Hena Mehta, CEO and founder of Based, a platform for women to gain financial independence, faced a dilemma. She had been admitted to an MBA program in the United States and was figuring out how to pay for it. The thought of taking out a massive student loan at the age of 28 scared him, but paying it off with his personal savings would have meant having none at the end of the program. While she now has a better idea of ​​when a loan should be taken, it was confusing then.

Wondering if taking out a loan means living beyond your means? When is the right time and in what scenarios should you take out a loan? Mehta gives us some tips to find out.

Let’s start with the basics. To pay for anything, you have two options: use your existing savings and investments or borrow money. Deciding which option to choose depends on several things. Some reasons are objective while others are subjective; depending on your situation and your personal preferences.

Construction assets

If the goal of a loan is to build an asset, such as a house or an education, then it makes sense to borrow money to pay for that purchase. A trump card is something we expect increase in value, pay dividends or generate long-term income.

However, if the purpose of the loan is to cover some personal expenses – which are basically living beyond what you can afford – then don’t take that loan. As for utility loans, such as those taken out for the purchase of a car, considering that you find a fairly reasonable rate of interest, can be reviewed as needed.

A funny acronym: DTI

You can’t talk about a financial topic without an acronym. The DTI, or debt-to-income ratio, is the portion of your monthly (net) income that is allocated to EMI payments. The principal of the loan + the interests are distributed over the duration of the loan to constitute the EMI. The rule of thumb and recommendation here is to ensure that this ratio does not exceed 30-40% to ensure a healthy personal cash flow.

Simple, right? So if you earn Rs. 10,000 (after tax) per month, make sure you don’t pay more than Rs. 3000-Rs. 4000 for all EMI payments. Lenders also take this ratio, along with your credit rating, into account when approving a new loan for you.

Credit card loan

Are credit cards the solution?

I’ll try to be brief and sweet here. Credit card loan is good when you are able to pay it off in full at the end of the monthly cycle. Not just the minimum amount, but the entire outstanding balance.

Why? Well, because credit card debt is one of the most expensive loans you can take out (interest rates are 35-40% per annum). However, if used responsibly, it can help build a good credit rating that could come in handy for other loans in the future, like a home loan or business loan. You also get free credit for one month at a time!

Beware: the debt trap

Going into debt to pay off debt is a slippery slope: for example, if you take out a personal loan (which usually has high interest rates) to pay off credit card debt. It can become a vicious cycle and you should try to avoid it. Eventually, paying off all the debts will become almost impossible. Some of the first signs that you might fall into the debt trap include a high DTI ratio (over 50%), a constant maximum of your credit card limit, too many outstanding loans and l inability to save money each month.

If you find yourself in the debt trap, try to pay off the expensive loans first, that is, the loans with the highest interest. Automate payments by keeping payment dates close to payday, so you don’t miss any IMEs. Above all, do not take additional loans. Review and redefine your monthly budgets and priorities to make sure your spending is under control and you are able to save. For a few months, consider limiting your spending to the essentials until you reduce your liabilities.

Zero interest loans? Yes please!*

Sometimes sellers offer Zero rate IME payment options to boost sales of their products. These are common for home appliances, electronics, gadgets, etc. Zero interest IMEs are a good way to save money and improve your credit score, assuming you can pay off the loan on time.
* Is there a catch? Perhaps. Make sure there are no hidden fees and charges if you are using zero interest loans.

Take a loan

Dos and Don’ts

Before you decide to take out a loan, ask yourself why you are doing it and if you can afford to pay it back on time.

To do :
Take a loan when you use it to build an asset
Make sure your DTI is well below 40%
Pay off your credit card bills in full, on time, every time
Use interest-free EMI options, assuming there are no hidden costs and fees

Not to do :
Don’t use loans to spend more than you can afford
Don’t take out additional loans if you feel like you might fall into the debt trap

As for the dilemma of paying for my MBA, I ended up going with a small student loan, and paying the rest with my savings. If I had taken out a larger loan, I probably should have taken a job with a company instead of pursuing my entrepreneurial dream. This decision was a combination of objective advice, as well as my personal career choice. Understanding both for yourself is the key!

Images: courtesy of Getty

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