It all began with a harmless SMS. It was those days when software engineer, 29-year old Ujjwal was looking for some money to repay a friend. His solo photography trip to Malaysia went well, with some stunning pictures. But, he had to borrow Rs 50,000 because he decided to visit neighbouring Vietnam as well when he went. He was wary of using his credit card overseas, so asked his colleague to wire the money. Two months later, it was time to pay back his colleague. The SMS from the bank offered a great deal, and the best part of it was that this loan would not be added to his credit card limit. Ujjwal took the bait and signed up for a Rs 1 lakh loan for three years.
As months went by, Ujjwal was approached by other banks. It is always nice to hear about your high credit score. The sweet talk makes even a discerning borrower feel great. Ujjwal was elated, and he felt the need to oblige everybody. New credit cards, new digital platforms offerings loans and even few of friends working in non-banking finance companies (NBFCs) offered him great loan deals.
Top credit card companies gave him three more cards. From Rs 2 lakh, his credit limit became Rs 15 lakh across four cards. Always paying off the minimum dues for each of his cards, Ujjwal’s credit card debt soared. A personal loan was offered to him to slash the interest costs of credit cards. The personal loan salesperson asked him to take a bigger amount in case he faced an emergency. Once he managed to reduce the Rs 26,000 credit card Equated Monthly Installments (EMIs) to Rs 18,000 EMI on personal loan, Ujjwal started rolling over the personal loan too. Every time he took a new loan, the personal loan provider asked him to take more than outstanding.
What he did wrong
Ironically four years after his Malaysia and Vietnam trip, Ujjwal was knee-deep in loans. His loan requirement from a mere Rs 50,000, had increased to Rs 6 lakh. More than half of his salary goes into paying EMI for the consolidated personal loan. None of his friends want to give him any loan.
So, where did Ujjwal go wrong?
Firstly, Ujjwal started out as a credit-worthy customer who then over-leveraged himself. It was an easy decision for financial institutions to lend to him. However, it is up to the borrower to practice restraint. Just like excessing eating, drinking or sleeping, excessive loans are injurious to financial health. Because somebody is offering you attractively-designed loans, it does not mean you should take them.
Secondly, like many gullible borrowers, Ujjwal fell into the credit card and personal loan vortex. Credit cards charge interest rates ranging from 30-42% per year. Such high interest means you should never use credit cards for one to two year tenure of loans. Once the outstanding starts getting accumulated, the entire loan becomes too big due to high-interest rate.
Thirdly, paying the minimum outstanding on credit cards is a big mistake. It is the minimum amount that has maximum impact. Try to pay all credit card dues, not just the minimum amount. Any amount that you do not pay attracts interest.
Fourthly, Ujjwal was sucked into more debt even as he tried to handle the situation. In a bid to reduce interest costs from his four credit cards, he took a personal loan. However, he took extra funds. Personal loan sellers will always try to give more, but you should consider the situation. More funds mean more debt, resulting in more repayment.
Lastly, every individual should assume only that much unsecured debt which they can pay off easily. As a thumb-rule, you should not take more than 20% of your monthly income in unsecured loan repayments. Personal loan, and credit card debt falls into the unsecured loan category.