6 Rules Every Millennial Must Follow For Smarter Borrowing

According to reports, India is on its way to become the country with largest and youngest employable population in the world. The report states the average age in India would be just 29 years in a couple of years. With such growing proportion of millennials in our country’s workforce, financial awareness becomes critical, especially when it comes to borrowing, as mistakes made while taking loan of any kind can have adverse long term implications on one's financial health. Today, I am sharing some tips for India's millennials in case they require loan -

Compare amongst various lenders: Before zeroing in on any lender, it’s vital for millennials to shop around to get the best deal. Do not blindly opt for the bank or NBFC which is nearest to your home or with which you have an existing relationship, or for that matter, one where you see the lowest interest rate. A lower interest rate does not necessarily mean you are eligible for it. Take the help of online financial marketplaces to compare the various offers available to you. Such platforms assist by matching the borrower with the right lender, according to the borrower’s needs and eligibility.

Avoid over-borrowing: One of the first rules that a smart borrower must abide by, is to avoid borrowing more than what one can repay. With so many categories of loans being offered along with high loan amounts, it’s quite natural for millennials to get tempted and therefore over borrow. What everyone must understand is that every loan comes with the obligation of repaying the principal along with interest applicable. Therefore, it’s always advisable to borrow only what you actually need. Never borrow with the motive to splurge or invest. Over borrowing may result in loan defaults and even land you in a debt trap, overcoming which won’t be easy, especially for a young earner.

Choose the loan tenure wisely: There’s no set definition or rule to determine the right loan tenure. It varies borrower to borrower, depending upon their financial situation. Someone in urgent need of money and looking to repay it quickly would opt for a shorter tenure such as 1-3 years, whereas someone with the same income and loan amount may take a longer tenure, such as 6-7 years, to avoid paying a higher EMI and straining his/her finances.

Even if one belongs to the high income group and has a good repayment capacity according to lenders, it’s not necessary to opt for short tenure and quickly pay off. Another way of borrowing for such individual can be to opt for a longer tenure to lower the EMIs, even if capable of paying a higher EMI, and prepay the loan partially or foreclose it after a few years. This helps in containing the monthly debt payment outgo and saving on the overall interest cost by prepaying/foreclosing the loan sooner.  

Timely repayments to create build good credit score: Millennials need to remember that their credit history starts building up once they have availed any form of credit, whether a credit card or loan. To build a good credit score, one needs to make timely and full payments for their credit card and loans. If you cannot manage a credit card wisely, it’s better to avoid taking one, rather than using it irresponsibly and damaging your credit score and loan approval chances. Same goes for loans as well. A disciplined approach towards credit card and loan repayment assists in building a high credit score, which in turn helps in fetching better loan deals and avail various benefits of credit cards.

Contain your debt to income ratio to 40-50%: Another vital component of smart borrowing is to maintain a debt to income ratio of up to 40-50%. This ratio reflects the proportion of your income currently being spent on debt repayments, such as credit card bills or loan EMIs.  A higher debt to income ratio depicts that a major portion of your monthly income goes out for paying these, leaving lesser room for managing savings, expenses or taking another form of credit. Lenders usually consider such borrowers as more likely to default in future and therefore may hesitate to lend them. Even if they decide to lend to such applicants, it's likely to be at higher interest rates.

Ensure creation and maintenance of emergency fund: Creation and maintenance of an emergency fund assist in keeping your financial ship steady in case of financial emergencies such as sudden job loss or severe illness. It ensures you do not have to take expensive loans to tackle these situations. The size of this fund should ideally be at least five to six times your monthly expenses, and the amount should rise proportionately upon an increase in your monthly expenses. Millennials may consider parking their emergency fund in high yielding savings accounts, since they offer the highest form of liquidity along with interest rates usually up to 7.25%.

Naveen Kukreja

Guest Author Naveen Kukreja is CEO and co-founder of Paisabazaar.com. He studied engineering at Delhi College of Engineering and holds a postgraduate diploma from IIM Calcutta