Getting instant loans is easy and so is falling in a debt trap
Same day approval; get an instant loan.
Lowest interest rate personal loans; get approval within 5 minutes.
No paperwork required; get an instant loan.
The internet is full of such advertisements. Getting a loan has really become an effortless task for eligible borrowers and even those less than eligible.
With growing digitalization, new-age fintechs and leading banks have remarkably accelerated the loan approval and disbursal processes. Convenience plays a major role, besides the rate of interest.
But credit always acts as a double-edged sword. Unless, you use it intelligently, there’s always a chance of falling in a debt trap.
So what is a debt trap?
Put simply, it’s a situation wherein you are unable to repay what you have borrowed through your resources and you keep borrowing more to service your existing debt.
There can be a plenty of reasons—the interest rate is high and unsustainable, you have borrowed beyond your means or there’s an unusual drop in your income and so on.
At present, the higher cost of borrowing won’t be a problem for borrowers since interest rates on most loan categories are at record lows. But lower borrowing rates and easy credit availability can disturb your credit discipline—a root cause for a debt trap in many cases.
You might wonder why we are discussing this topic now, and more so, being a non-bank broking house.
Simply because, individuals are piling up loans at a time when corporates are deleveraging their balance sheets. Moreover, if global central banks, including our own RBI, decide to tighten up the noose, interest rates might gradually go up.
Credit cycles in an economy keep rotating but habits of borrowers don’t change as often as them. Simply put, depending on the economic conditions, borrowing rates can go up and down, but if you develop a habit of borrowing indiscriminately when the interest rates are low, it’s very difficult to break it even though the rates start rising.
Individuals are borrowing more, data says so:
- Google has revealed an interesting observation about Indian borrowers—search interest for loans from cities beyond Tier-1 is growing 2.5X.
- According to RBI data, personal loans have witnessed a double-digit growth every year for the last 10 years and their share in outstanding bank credit has increased from 16.4% in FY11 to 25.9% in FY21.
- Household debt-to-GDP ratio was 37.9% at the end of 2020. This has been rising steadily from 32.5% in March 2019. A higher ratio indicates greater indebtedness of a society. True, a drop in GDP during the pandemic could be a reason but the trends beyond the pandemic need to be tracked closely. Possibly, people might have also borrowed to deal with contingencies related to the pandemic.
- The average ticket size of a personal loan has fallen from Rs 2.4 lakh to Rs 1.5 lakh between FY17 and FY21. But this data should be interpreted carefully since there’s been a 3.8 times jump in the disbursal volume between FY17 and FY21. Does that mean individuals are borrowing frequently, as and when needed?
- Further the share of bank credit to individuals within the households segment, which includes proprietors and HUF amongst others, has increased to 43.3% from 34.2%
We are not saying the present situation in India is alarming but why wait until piling debt traps you.
How much should you borrow at max to avoid a debt trap?
Frankly, that depends on your future income expectations. As a ballpark figure, when the ratio of EMI (including all EMIs) to monthly income crosses 50%, you should become careful.
If you are expecting your income to rise substantially in the immediate future, you might go for an EMI to monthly income ratio of upto 65%-70%. That said, you must avoid accumulation of incremental debt when your income rises in future.
It’s important to have a right approach to borrowing
If you are borrowing to create an asset which is sustainable, it’s different. But if you are borrowing for leisure, lifestyle or even emergencies, you might perhaps want to revisit your strategies.
Not that enjoying a holiday with borrowed money should be avoided completely but if EMIs on such loans fall out of thresholds mentioned above, then it’s definitely a cause for concern.
If you often end-up borrowing for emergencies, it’s better to build a contingency reserve.
And as they say, you should save before you spend and invest before you borrow.
It might sound old school but not everything that’s old school is outdated.
And here’s a point we want to make as a stock broker
According to Credit Information Company (CIC), India has 20 crore unique credit active individuals—around 50% of India’s estimated working population. As against that, there are only 7.4 crore active demat accounts (2.4 crore with NSDL and about 5 crore with CDSL).
It means there’s a long way to go before we can celebrate financial inclusion in true sense.
If you are amongst those 12.6 crore Indians who are actively opting for loans but are yet to have a demat account, hurry up, open a free-online demat account with us today!
Isn’t it strange to have a bank account, own real estate, take loans against properties and yet not have any exposure to equity? As an asset class, it’s been beating inflation consistently over longer time periods.
Investing online is as convenient as borrowing online. It helps you build wealth. Why wait any longer? Open a free-online demat account with us and start investing in financial markets.
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Disclaimer: The blog is for information purposes only and anything mentioned herein shouldn’t be construed as a fundamental reason to buy/hold/sell any stock or a mutual fund. Furthermore, the information provided in the blog and observations made therefrom shouldn’t be treated as the extension of recommendations made on the other properties of Ventura Securities.
We strongly suggest you to consult your financial advisor before taking any decision pertaining to your finances. Asset allocation becomes extremely relevant.