4 important things that you must keep in mind before you take many loans
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4 important things that you must keep in mind before you take many loans

  • Highlights

  • Multiple loans can have a severe backlash on your finances, if not planned well

  • Check your debt to income ratio to know your financial health

  • Ascertain the utility of the loan

  • The rate of interest on the loan should be < rate of return on investments

As a professional, you juggle multiple responsibilities, from managing various work-related expenses to personal ones. You have many financial needs to cater to, making you consider to take a new loan.

However, taking multiple loans can have a severe backlash on your finances if not planned correctly. Here’s what you need to keep in mind before you take on additional loan responsibility.

1. Check your debt to income ratio to ascertain your financial health

Before you start taking many loans, you should always evaluate how many EMIs can you afford. Financial experts say that if your EMIs cost you more than 50% of your income, it is an unhealthy sign and it could increase the chances of a loan default. So, it is essential that you calculate how much you are spending towards EMIs with respect to your income and see if you can afford another EMI payment.

Pro tip: Take another loan only if all your loan EMIs (your old loan EMIs + the EMIs of the new loan you plan to take) are 40%–50% of your net monthly income. Such a conservative approach will help you save for vital life goals such as retirement, your child’s higher education, or for urgent medical and hospitalisation needs.

2. Ascertain the utility of the loan

Before you take another loan, you should thoroughly know the purpose or the usage of the loan. Only if you are in absolute or urgent need of funding, then only should you take another loan obligation.

Pro tip: Don’t take multiple loans so that you utilize the funds for investment purposes. In case this turns out to be a bad or a dead investment, not only does it erode the money that you’ve invested but also makes you indebted to pay the principal of the loan with an added interest component.

3. Evaluate if the rate of return on investments is higher than the rate of interest

Although it isn’t a best practice to take loans for making an investment, when you already have an existing to loan to pay, you should only do so when the rate of return on investments is higher than the rate of interest on the loan. For example, the rate of interest earned on safe investments like fixed deposits and bonds wouldn’t be higher than that you pay on a loan. Return from other investment sources like equity being subject to market conditions, are volatile and uncertain in nature and hence are not strong reasons to take a loan when you’re already in debt.

Hence, if you are not very sure about the investment avenue generating returns or think it has a high-risk associated with it, then it is better to defer such investment needs as you already have your existing loan’s EMIs to pay.

This would help you to be safe from falling into a debt trap.

Pro tip: If you’re taking the loan for business purposes, ensure that you’ve clearly drawn out a revenue plan from the investment made. This will help you in being ensured at the planning stage itself if it’s prudent to take a loan and will make repayment much easier.

4. Calculate if you can close or part prepay the existing loan

While planning for a second loan, compute the outstanding amount of your existing loan and check if you can prepay a part of this amount or foreclose the loan entirely by using your savings or earnings from investments and other sources. This will help you get debt-free quicker, and make taking and managing a second loan much easier.

Keeping these factors in mind, decide whether it is a good time for you to sign up for a second loan.

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