A Smart Plan to Become Loan Free (In India not America)

There is sharp difference between an Indian trying to become loan free, and an average American tying to achieve the same goal. What is the difference? Americans handle loans differently than us. They have a more casual approach towards it.

But in India, people handle loans more carefully. This is not because we are better in handling money, it is because American’s are more affluent. They can afford to handle debt with some carelessness.

Let’s try to understand it with an example. Suppose there are two people A & B. Person “A” earns Rs.5.0 Lakhs a month, and “B” earns Rs.1.0 Lakhs a month.

Suppose both of them took a loan of Rs.40 lakhs for different reasons, for which the EMI cost is Rs.40,000 a month.

What do you think, who is more likely to handle the EMI with greater caution? For person “A”, his EMI is only 8% of his monthly income. But for person “B” it is 40% of his income.

Beyond doubt, person “B” will handle his loan EMI’s more carefully. Why? Because a major portion of his income is getting used by the loan.

In this example, “A” is a typical American and “B” is an average middle class Indian.

What is the point?

Recently I was reading an article published by an American blogger on how to get out of debt. It was a great article, but the points that he covered were actually looking less-relevant for Indian audience.

He covered almost all the concepts about transforming self from “being debt-ridden” to “becoming loan free”.

But I thought that the way he has approached the idea of becoming debt free may not be completely relevant for an Indian reader.

Hence I thought to put my own views on the subject of ‘becoming loan free in life‘.

Why you should read me on this topic?

Because by the time I was in my 40’s, I was able to take myself out of the loan cycle. So what I will share here are my personal experiences.

It took me close to 6 years to finally become loan free. Actually, the plan was to become loan free in 10 years. But the smaller the loan outstanding became, it motivated me to try harder.

How a person can become loan free in life - Loan Balance Reduced in 6 years

After my fourth year, a stage came when I started pushing myself more aggressively to become loan free. By the time I was in my sixth year, I was debt free.

But important was not the last 2 years, critical was the initial four years. Why? Because in last 2 years the motivation was high. In the initial 4 years, it was tougher to keep myself goal-bound (there was less motivation).

So let me share with you my plan of becoming loan free in 10 years.

A Plan: To Become Loan Free in 10 Years

I have intentionally added the time line of 10 years into the plan. Why? Because of two reasons:

  1. Simple Reason: To set a visible target.
  2. Less Obvious Reason: To highlight the magnitude of the task in hand.

What I mean by “magnitude of task in hand”?

For a person whose income is high, he can do both:

  • He can be casual in handling loan.
  • He can also pay-off loan comparatively easily than other people.

But for a middle class Indian, becoming loan free is one of the tougher financial goals of life. It will take time to convert this goal into a reality.

May target was to do it in 10 years. Other can set a lower or higher timelines based on their plan.

What was my plan to become loan free?

There were two important entities of my plan:

  1. How to reduce loan? Prepay the loans.
  2. How to get the prepayment amount? Generate more savings.

I just followed these 2 steps to become debt free. This plan has been shown in the below infographics.

How a person can become loan free in life - The Plan 5

#1. Prepay the loans…

In America people call it “paying off the debt”. In India we call it ‘part-payment of loan’ or ‘prepayment of loan’.

I have written a separate blog post on loan prepayment. I will request you to read that piece as well. I am sure it will add another dimension to your understanding about loan management.

Digging deeper into my loan prepayment plan – there were 4 important sub-plans to it. Allow me to touch upon each sub-plan briefly.

  1. Listing down all loans: For Americans it is an essential step because they carry variety of loans. But for we Indians we almost remember our loans as good as our salary. But still, listing down all loans is required. It will help in our next sub-step.
  2. Sorting of loans: Suppose one is carrying three types of loans: Home loan, car loan, and credit card balance. Sort these loans in the order of decreasing interest rate. Credit card charges the highest interest rate, So it will come first. Home charges the least, hence it will come at the last.
  3. Prepayment: Out of the above 3 loans, which must be prepaid first? Credit card debt. Why? Because it is the costliest debt. This is an important rule. No matter how small is the loan value, always pay-off the costlier debt first. Moreover, when we make prepayment we have two choices. We can either reduce the EMI or loan tenure. I personally opted for EMI reduction more than tenure reduction, though tenure reduction is more profitable.
  4. Tracking Loan: Though this step looks obvious and less important, but it has its own indirect benefits. How? Tracking loan does two things for the borrower. First: it makes the person totally aware of the loan balance. Second: As we start preying the loans, tracking can further motivate the person to continue prepayments months after months.

Further Reading:

#2. Generate More Savings…

What we have seen till now is that, prepayment of loan can make one loan free. But there is a bigger problem that will be handled in this step number two. What is the problem?

From where to get the amount required for making the prepayment?

There are two ways to do it:

  • Borrow from family.
  • Generate your own savings.

Generating savings is the best alternative. But ‘savings generation’ is a desire, which is easier said than done. To generate enough savings, a further sub-planning will be necessary.

Lets see the sub-planning related to savings generation:

  1. Extra income generation: For a salaried person, extra income generation can happen by giving more to the work, which in turn will pay-off in terms of salary increments and performance bonuses. Every extra penny generated can go a long way in building savings. Other way of income generation can be converting ones hobby into an income source. I converted my passion for investment into a blog.
  2. Budgeting Expenses: When priority is loan prepayment, one cannot afford to overspend. So how to stop overspending? By preparing an expense budget and sticking to it at all times. While building a budget, set a target for savings. Pay yourself this amount first thing in the month start.
  3. Stop Investments: I took this call. Before, ‘becoming loan free‘ became my priority of life, I used to invest reasonably in mutual funds and stocks. But I stopped all of that – for few years. Whatever extra I saving from my income, I was diverting most of it for loan prepayment.

Further Reading:

Conclusion…

It is much easier to accumulate debt, than to get out of it. The analogy is very similar to weight gain. Due to bad eating habits people gain weight. Similarly, due to bad money management, people accumulate debt.

In order to shed weight, people has to compromise on their food intake, and also take-up gymming. To reduce loan burden, one must cut their spending habits.

Both these tasks require lot of discipline in life.

Prepayment of loan is the trick which works very effectively to reduce the loan burden.

Though lot of people know that prepayment is the best solution to get out of debt, but only few can actually accumulate sufficient savings for full prepayment.

In this article, we have seen process, using which one can build enough savings and ultimate use this money to prepay all loans.

2 Comments

  1. For Maxgain home loan of SBI,

    Which option is better,

    1. Prepayment

    2. Keep excess money into Maxgain account

    Please suggest

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