EMI’s (Equated Monthly Installments) are a great tool to manage your cash flow. You can get almost everything on EMIs, from your favourite phone to AC/Fridge/Washing machine including a trip to your dream destination. You see these type of EMI ads everywhere these days from online (FB/Instagram/Blogs/websites) to offline (Shops/Hoardings).
We all know the benefits or advantages of EMIs. It’s super easy to take it. You can get it without any collateral and with the click of a button in most cases (Multiple credit cards offer EMI option at check-out).
No cost EMI is probably the most sought after financial product right now all over the world. However, excess EMI‘s can destroy your financial freedom. We will talk about how to identify the excess EMI trap early on in this article to save you from sliding into the debt trap.
We will look at the EMI from 4 different viewpoints to understand if you are using it the wrong way. Now let’s deep dive without any further delay.
1. EMI as a portion of Your Income
- EMI exceeding 50% of your income – We fall prey to ‘easy EMIs’, ‘discounts’, and ‘sales’. Compulsive spending can strain your finances and push you towards a debt trap. “Some or the other sale” will always be on to lure you into this trap. People who can’t control themselves often end up buying things on EMIs. So to keep things in check, always remember – your total EMI should not be more than 50% of your income.
- Fixed Expenses or obligations of more than 70% of income – EMI is only a part of your fixed expenses or obligations. There are several other fixed expenses — Rent, society maintenance charges, kids’ school fee, etc. Ideally, the fixed obligations-to-income ratio (FOIR) should not be more than 50%. Generally, Banks and NBFCs look at this ratio as a filter before giving out any loan or credit card. Trust us, you don’t want to screw this.
2. Use of EMI: For what purpose are you taking the EMI
- EMI for regular expenses – If you often find yourself borrowing money (EMI) to meet regular expenses, you need to set your house in order. If you have to borrow (EMI) regularly to meet routine expenses — rent, kids’ school fees, etc. — you may be sliding into a debt trap.
- EMI to repay a credit card dues – If you’re required to borrow money (EMI) to repay an existing loan or credit card dues, it is a worrying sign. You are just revolving the money from one party to the other, and at the same time, you are paying the interest part from your pocket to both the parties.
These are the traps you are setting up for your future self. It is very hard to come out of these. It may end up costing you years just to settle everything down.
3. Usage of Credit Card: Where most of the EMI fun happens
- Withdrawing cash from a credit card – Using a credit card for the regular expense is a great way to manage cash flow while getting all the discounts at the same time. But when you start withdrawing cash, you are heading to trouble. Cash withdrawal from Credit card invites a chunky cash advance fee — 3.0% – 4.0% of the withdrawn amount per month. Annually, the interest works out to be 36% – 48%. No matter what, never withdraw cash from your credit card. It’s not worth it.
- Not clearing credit card dues – Not clearing the credit card dues in full is a huge red flag. Our survey shows that this practice of not paying the credit card bill in full is quite rampant. 21% of the respondents have either missed the credit card payment or rolled it over by paying the minimum due amount over the past year. Credit card companies make money only when you pay the minimum due or don’t pay at all by charging your 3-4% monthly interest rate on the outstanding balance. While you still have to pay the penalty fee as well.
4. Other Indicators
- Missed utility bills payments – Missing utility bills once in a while is not a warning sign. However, frequently missing paying utility bills, means you may be spending beyond your means, and it’s a red flag. The fact that this will impact your credit score and may keep you away from low-cost funding options. It also indicates a lack of financial literacy.
- Borrowings based on future one-time bonus – If you decide to take a loan now basis expectation of getting a fancy bonus later this year, you may be in for trouble. People always hope for the best and don’t factor in possible problems that may emerge in the future. So, borrowing based on current salary is fine, but never on expected bonuses, increments etc.
Now, you must be interested in knowing if you are in full control or not. To check that, build your credit profile on RefreshMint App. We use Experian bureau data to check your borrowings and compare it with your Income.