How to borrow responsibly

Make a clear distinction between frivolous spending and crucial borrowing

Most mails from young earners ask me a simple question: is it possible to get through life without borrowing? The simple answer to this question is, no. The extreme views that society seems to hold against borrowing has possibly led young debtors to wallow in guilt, remorse and shame, unable to restructure their financial lives meaningfully. We need a more realistic, helpful and practical approach to spending borrowed money.

Assume that all of us decide to live within our means. We can argue about it, but our routine spending decisions impact our happiness quotient. We make three types of borrowing and spending decisions. We need to recognise which one we like to do the most, how it impacts our finances and happiness to ensure we have borrowed and spent sensibly.

The first kind that will be dismissed as pure hedonism is consumption expenditure. Shopping for clothes, taking holidays, eating out, spending on friends are such expenses with no obvious economic outcome, except a high happiness quotient. Austerity flag bearers will junk all of them. Those who give youngsters the spiel on curbing such spending do not know the magical impact a new outfit or watch can have on their social lives or its emotional pay-offs. Instead of condemning all such spending, a good place to begin is to nurture the habit of doing so responsibly.

There are three things a young earner can do to manage consumption expenses. First, take the time to prioritise. Second, allocate a mental budget not in terms of rupees, but in terms of your income. If a holiday with your friends to exotic locations matters the most, allocate, say, one month’s salary in a year to it. Three, make the most of this money. If you have set aside 40,000 for the purpose, do not fritter it away by booking in 5-star hotels over weekends, where your unwinding ends before it begins. Ensure you have planned well, hunted for bargains, chosen off-season timings, booked in advance and made the most of your money.

Impulsive decisions are the enemy of happiness expenses. Learn to plan ahead, even if you like to buy a surprise gift. If you borrow to fund your happiness expenses, do it with a clear repayment plan. Good advice on credit cards is ubiquitous-use a debit card, plan ahead and get a cheaper personal loan, borrow against your deposits and repay regularly. If you have gone overboard and piled up a big debt, seek help. Restructure and be prepared for severe cutbacks.

The second category of expenses for which most youngsters seek a loan is the buying of durables. This is one notch above the purely emotional happiness expense. We have a car, a fridge, a TV or a bike to show for the debt we have assumed. In several cases, these expenses have indirect savings, enhance our productivity and enable us to lead better quality lives. Most youngsters buy their own vehicles to commute. An air conditioner or television is no longer seen as luxury. Most first loans are for buying these goods. How does one make these decisions? First, make an estimate of the duration for which you will use the product. If you think you will change your television in three years, there is no point buying a 60-inch monster to feel good. Divide the cost of the product by the number of months for which you will use it. This is the approximation of your monthly cost. Most of these goods have limited end value and depreciate as soon as they are bought. Second, ask yourself if you can afford to spend this money as a percentage of your income. For example, if a bike costs 72,000 over a threeyear period, its monthly load is 2,000. If you buy a car for 3.6 lakh, it is 10,000. Add fuel expenses, and you will know the realistic expense you want to incur on commuting to work. Which one you choose depends on how much of your income you will allocate. You will also know that you have to take the public transport till you can afford either.

The third category of borrowing is for acquiring long-term assets. Most youngsters take an educational loan and this is best repaid before acquiring any other loan, even if it means devoting a large chunk of income to do so. Most cannot buy a home without resorting to a loan. These are necessary borrowings

and result in a long-term, economically useful asset. A young earner should wait to stabilise in terms of job, location, and other long-term decisions such as marriage, care of parents, etc, before taking a housing loan. Servicing home loans over a long period is fine as long as it does not take away too large a portion of your income. The thumb rule is to not have long-term loans that take more than 25% of the post-tax disposable income of the household.

So which types of loans should be avoided? Borrowing to buy an IPO, taking margin money to play on stocks or leveraging to take on derivative positions are all speculative activities. If you are not buying lottery tickets, you won’t do any of these. Take the time to decide the kind of spender you are and how you like to allocate your borrowing among the three kinds of spending listed above. Make an informed and conscious choice.
 

Courtesy:

Uma Shashikant
—The author is Managing Director, Centre for Investment Education and Learning, and can be reached at uma.shashikant@ciel.co.in
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