The Telegraph
Monday , August 1 , 2011
Since 1st March, 1999
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Check out for these symptoms in your day-to-day life : 1. Difficulty in paying bills on time

2. Never have enough money for emergencies

3. Total debt in excess of 50 per cent of annual income

4. Living from one monthly pay cheque to another

5. Often feel unhappy at home or work, and

6. Feeling frustrated for not having the things that you want, such as a new car or going on an exotic vacation.

Chances are you have got “Spender’s disease” — Wells Fergo financial adviser Steven Sanders would tell you so.

Spender’s disease refers to the tendency to borrow money without considering your capability to service the financial liability from your current and future income if interest rates go up.

Initially, you may not be able to assess its impact, but if you had followed the recent world economic developments you would know that overleveraging has almost brought the world’s richest nation, the United States of America, on the brink of collapse.

Worrying signs

India remains unscathed by the global economic crisis, thanks to the saving habit of its people. But the continuous tightening of interest rates by the Reserve Bank of India over the last one-and-a-half years had already started revealing the ugly effects of borrowing, not only in the corporate sector but also in retail, by increasing bad loans in the books of banks.

Credit is no longer a taboo, at least for the younger generation. Peep into the purse of an average Indian who is in his mid-twenties and earning Rs 3-4 lakh a year and you couldn’t miss two or three credit cards in it. Ask him and you would know that he has recently bought a jazzy motorbike with a bank loan and plans to take a home loan soon.

Not that credit is bad. A small dose of credit actually increases your spending capacity and this in a multiplier effect helps economic growth. For example, the easy availability of credit at a cheaper rate had propelled the housing market that in turn helped to create more employment and industrial growth.

But problems arise when the borrowing is too high in comparison to one’s income. This affects one’s repayment ability in the future in case the interest rates rise. Thus, looking only at EMI without giving proper consideration to the risk of a rate rise in the future may spell disaster for your finances.

Rate spiral

It is clear from the table that prime lending rates of the country’s three leading banks in the housing finance market went up 2.5-4.75 percentage points between April 2010 and July 2011. Assuming that these banks pass on the latest rate hike by the Reserve Bank by increasing their individual prime lending rates, we’ll be looking at an increase in PLRs of these three banks by 3-5.25 percentage points over a period of 15 months.

What does it mean to an existing borrower?

A 5 percentage point increase in lending rates will mean for every Rs 1 lakh principal outstanding at the end of March last year with five years remaining for repayment of the loan, EMI would have now gone up Rs 378. Imagine, if you have an outstanding loan of Rs 10 lakh with a remaining loan tenure of five years, your EMI in the last 15 months would have gone up by Rs 3,780. Has your monthly income during this period gone up to this extent? If not, then how are you going to cope with this increase in EMI? Think what will happen if you have more than one loan and other fixed payment obligations, such as an insurance premium.

Borrowing formula

The only way to cope with this situation is to prepay at least part of your existing loan so that the increase in EMIs is within the manageable limit.

When a bank gives, say a home loan, it generally considers 50 per cent of the borrower’s monthly income as his/her EMI paying capability. You can consider this is as the thumb rule to decide how much your total borrowing should be compared with your income.

When a bank considers 50 per cent of your monthly income to decide how much loan you are eligibile for, the basic assumption behind it is that your monthly income will grow by 50 per cent during the loan tenure so that you can repay the full loan in time.

However, one should remember that the borrower’s loan repayment capacity is measured at 50 per cent of his/her monthly income assuming he/she doesn’t have any other loans or fixed payment liabilities.

Avoid defaults

The borrower’s loan repayment capacity should be considered on the basis of the net take-home pay rather than the gross income.

Thus, if you have a take-home income of Rs 25,000 net of all statutory deductions and fixed pay obligations, your total EMI payment combining all loans should not be more than Rs 12,500.

In other words, your total loan outstanding should be around Rs 11 lakh assuming an interest rate of 10.5 per cent and a repayment period of 15 years. Any loan amount above Rs 11 lakh should be prepaid.

If your EMI obligations taking into account all outstanding loans, including credit card payments, has exceeded more than 50 per cent of your net monthly income, you should consider prepaying part of the outstanding loan to avoid any default. Any default in repayment will be recorded in your credit history and lenders may not be willing to give you a fresh loan in the future.

Experts believe that the Reserve Bank may increase its policy rates further in November-December if the inflation doesn’t cool down significantly. Hence, don’t be reckless in your spending habits since what may seem a comfortable buy now can turn out to be a liability beyond your reach.

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