Loans act like a bridge between your current financial status and dreams which you can’t afford. But how to use loans to your benefit, what are different types of loans available?
We all borrow money either from a bank or from people which can be termed as a loan, there are various types of loans but these can be generally categorized into two types and managing those two types of loans properly can really decide your financial future.
Two types of Loans
The process of borrowing money from either people or bank to satisfy our need is termed as a loan. There are many types of loans – house loan, gold loan, bike or car loan, personal loan, credit card loan etc. But, all the above-mentioned loans fall into two types of loans – high-interest loans (Personal loan, credit card etc), low-interest loans (Home loan, Gold loans).
Why the interest varies?
Interest varies on different loans because of the security (that is) when the banker or money lender has more security then he reduces the amount of interest and as the security level reduces the interest increases. Let me give you an example –
- When you apply for a house loan, you are incurring a loan on a property which can’t be carried away or stolen so the banker has more security on the money he has given you so the interest would be less.
- The second case, if you take a Personal loan or loan on a credit card which is purely cash and less secure which means the banker is just relying on your transaction history and believes that you would pay back the loan amount back and as the security for his money is less the interest is more.
Loans are not bad
Loans are not always bad because without a bank there would be no scope for business to improve and money to grow by itself (Fixed and Recurring deposits). Our dreams of a vehicle, higher education, home etc. can never be fulfilled without banks.
But, we should know how to use the loans for us instead of against us. What do I mean by this? I mean, many use the power of loan against them to invite unnecessary problems.
High-interest loans are bad
When you are planning to stay in the same home for more than 7 – 10 years it is better to go for Owning the home than to stay in a Rented house (let’s discuss on this in detail at a later point in time). But, when you have a high-interest paying loan and low-interest loan at the same time then what you should do is give high priority to the high-interest loan and clear it off as quickly as possible.
Loan Exercise for today
List out all the loans you actually have today and categorize them into either High-interest or Low-interest loans, if you only High-interest loans then try to quickly repay them back else they would eat you alive (you would understand this if you calculate how much percentage of amount you are paying back as interest for such a short period of time).
How to repay your loans if there isn’t any increase in your income? Money saved is Money earned, try to list out the expenses which you can let go for some more time and pay back your loans first. Once you become high-interest loan free then you can go for luxuries.
Don’t hurry to repay the low-interest loans
Low-interest loans are a boon in disguise because of the long period of time span which they are incurred, for example, a house loan is incurred for a period of 20-30 years and it seems as if you are paying more interest than the principal amount you have taken loan for, but there are many other factors causing this like – inflation, land cost increases.
As the time goes on
- Your interest would be more or less the same, but the value of money reduces due to inflation (which makes it easier to pay the EMI easily). While the extra money you have can be used to avoid High-interest loans and can be invested in Equity, Mutual Funds etc for helping your money grow ahead of inflation.
- If you repay your house loan completely then you can’t avail the tax benefit. So, don’t clear your house loan completely, instead keep some loan amount outstanding so that you can avail tax benefit with that loan.
- Your income increases year by year while your EMI amount remains same, so invest your money instead of repaying the loan.
- Go for buying a second house once you become comfortable to pay the second house EMI which can become an asset putting money into your pocket.
I have learned that a loan is nothing but a liability which takes out money from our pocket, so why not clear of bigger liabilities (high-interest) as they are taking more money and leverage the smaller ones with our intelligence to reap maximum profits out of them.
So, hope I have put forth my point clearly in front of you to free yourself from high-interest loans and use low-interest loans for your benefit.