Facing a debt overload? Here is how you can manage it

There is a significant portion of the population that finds a sense of security in the knowledge that they can access a reserve of money in the form of loans and credit cards whenever the need arises. Whether it be purchasing a dream home, the latest gadget, or booking a trip for a picture-perfect vacation, more and more Indians rely on credit to fulfil their aspirations and handle unexpected situations.

The prevalence of increasingly using debts for various needs and goals has resulted in the problem of debt overload. Lack of adequate financial literacy and unfamiliarity with the workings of credit card debts and loans make effective debt management a challenge. The ready accessibility of credit makes it easy for many to fall into a debt cycle because they mistakenly believe that they can always pay back the EMIs and loans later.

However, before you realize it, the high-interest rates attached to credit card dues make your debts snowball that starts eating into other areas of your finances. It is crucial to be cautious and avoid this slippery slope to keep your finances under control.

Knowing the difference between good debts and bad debts

Debt overload can have various negative impacts on your financial situation, such as reduced credit scores, decreased savings, and losses on investments you may have withdrawn to pay off debts. Hence, it requires a well-thought-out and comprehensive approach to manage the burden of debt effectively. To avoid getting trapped by the tentacles of debt, it is crucial to differentiate between good debt and bad debt. Debt used to purchase assets that increase in value and carry low fixed interest rates are good debts, whereas loans used to buy things that depreciate and have high or variable interest rates are bad debts.

Your repayment strategies should not be random; rather, they should be formulated on the kind of debts you have incurred. You can choose either the debt snowball or the debt avalanche approach. The latter is more appropriate for large, high-interest loans as it helps to minimize interest payments and will also help you avoid using savings or investments to pay off debts. High-interest rates can become unmanageably large if left untended to for long periods of time. The snowball method entails paying off your smallest loan as fast as possible and then using the money previously allocated towards that payment to tackle the next-smallest debt. This process continues until all debts are settled, with the aim of gradually eliminating all outstanding balances.

Streamlining repayments and goals with mutual fund investments

Depending on your debt liabilities, different strategies are needed to manage good debts and bad debts. This points out that the burden of debt can consume more funds than you earn from investments, citing credit card debt as an example. In many cases, the interest paid on credit card debt can exceed the returns earned from investments over a year if not managed properly.

Paying off bad debts, particularly credit card debt, should be a top priority and must be addressed without any exceptions. The recommended approach is to tackle debts with the highest interest rates first. If possible, debt consolidation or refinancing options that reduce the overall interest rate or monthly payments can be beneficial.

When it comes to good debts, you can use various allocation models and invest in a mix of equity and debt mutual funds. Even if you are dealing with a significant debt overload, investing a small amount in equity mutual funds can help establish healthy investment habits. Instead of taking on debt for large expenses like vacations, cars, or jewellery, it's best to plan ahead and save up for such goals. Allocating funds across equity and debt mutual funds can be an effective way to achieve such objectives.

If you have a high level of debt – to the extent that your financial goals are getting impacted due to debt repayment – you may need to alter your lifestyle to control expenses. In some cases, to declutter a debt mess, you may also have to utilize your savings to repay outstanding debts. However, in some cases, restrictive clauses in loan pre-repayment terms may make it difficult to make monthly repayments with these savings. You can tap into mutual funds here – you can invest the savings in money market funds or liquid funds. The accumulated capital can then be used at the end of the year to make pre-payments and reduce outstanding debt. What's more, if you are left with a surplus after repaying your debts, you can reinvest them for your goals. This approach helps you let your savings appreciate instead of leaving them idle and also helps you stay on track with your investments.

An Investor education and Awareness initiative of Aditya Birla Sun Life Mutual Fund

All investors have to go through a one-time KYC (Know Your Customer) process. Investors to invest only with SEBI registered Mutual Funds. For further information on KYC, list of SEBI registered Mutual Funds and redressal of complaints including details about SEBI SCORES portal, visit link : https://mutualfund.adityabirlacapital.com/Investor-Education/education/kyc-and-redressal for further details.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully

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