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    How to deal Credit Card Debt using Personal Loans

    Most of India’s corporate employees and youth that got rich overnight through exorbitant salaries have fallen into the pit of credit card debt.

    It’s not easy to avoid this trap with pre-approved credit cards being available literally everywhere and from every bank – offering excellent offers and benefits in addition to the ability to shop now and pay later. It’s an enticing offer, and the irresistible urges that many of us have to shop or to seal a great deal instantly could be what ends up trapping us in debt.

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    The problem wouldn’t be as severe if each of us had only one credit card that we had to pay off. Most spenders have multiple credit cards that they rotate in order to keep the outstanding amount even between the cards, and not extremely high on any one particular card. While this is a good practice, it also brings with it the problem of having to deal with multiple interest rates, repayment amounts, penalties, etc. from different sources. Dealing with debt from one source is bad enough, but having to deal with four or five banks constantly hounding you for repayments is a fate worse than death.

    Let’s take the example of Mr. Babu from Bangalore who unfortunately fell into the pit of debt, but climbed out of it unscathed thanks to this one underrated debt-management trick – debt consolidation.

    What is debt consolidation? It’s when you bring together all your outstanding debt from various sources under one single head – and owe one party a large sum instead of owing multiple parties smaller sums. Managing one source of outstanding debt is much, much easier than having to field five or six of them.

    Mr. Babu had accumulated 6 credit cards over the 3 years of his corporate employment. Banks just kept approaching him and offering him credit cards for which he was “pre-approved”. He had one petrol-card which gave him rewards if he used it at petrol bunks, one shopping-card that gave him discounts and offers at select merchants, one air-miles card which credited a lot of potentially free travel miles if he used it to buy air tickets, and 3 general use credit cards.

    Since these cards had no annual fees, Mr. Babu took them all and kept them in his wallet thinking (as we all have) that he could and would only use them in an emergency, or to get flight tickets for cheap and accumulate air miles with his air-miles card, or get discounts on shopping with his shopping-card, or to get free fuel after a certain number of visits to the petrol bunk with his petrol-card.

    Being a man of a disciplined constitution, Mr. Babu resisted the temptation to use these cards for impulse shopping and deferred to his better judgement – knowing that he could purchase anything he wanted, but also knowing that he needn’t.

    This did not last long, as pretty soon, he used his air-miles card to book tickets to Delhi to meet his family. He received a tiny amount of air miles, and maybe 10 more trips between Bangalore and Delhi could get him a free trip. Once he reached, he rented a car with one of his other cards, and used the petrol-card to fuel it up – receiving a tiny number of points which could maybe get him a litre of free fuel after 20 more trips to the petrol bunk. Once he met his family, he took them out for a day in the city using only his credit cards. Fuelling up, swiping after meals at fancy restaurants, shopping (and earning tiny amounts of rewards points), and purchasing a large household appliance for his family home. He did not spend even a Rupee in physical cash on his Delhi trip and felt a certain amount of satisfaction at the convenience and ease with which he was able to manage his trip finances.

    But, little did he know, he’d opened up Pandora’s Box of debt, as his credit card using habits continued even once he was back in Bangalore. He would use his cards instead of cash every single time, even in cases where he could use cash to complete the transaction.

    He was able to meet the payments every month thanks to his monthly salary, and was enjoying the benefits of EMIs on everything and staggering future payments on immediate purchases.

    Around 6 months in, Mr. Babu had accumulated around Rs.4 lakh in credit card debt which was being easily managed, as Mr. Babu is a man of financial discipline, and was meeting all his payments on time, every time. His salary was sufficient to meet payments due, and he was able to rotate his funds between salary, debt repayment, and managing his own lifestyle. A few months later he had brought his debt down to Rs.2 lakh through regular payments.

    But one fateful day, Mr. Babu’s boss called his entire team in for a meeting and told them that their company was facing losses and had to terminate his entire team.

    Since Mr. Babu was managing his finances through a cycle of debt – this would affect him in the worst way. That month, Mr. Babu wasn’t able to meet his monthly credit card due and was subsequently charged with penalty interest and charged for missing payments – by 6 different banks! His total outstanding went from Rs.2 lakh to Rs.3 lakh just in that one month. That’s when Mr. Babu realised the following:

    1. Credit card interest is charged monthly.
    2. Penalty interest on credit card overdue payments that have not been made are compounding in nature.
    3. Penalty charges for unpaid credit card dues in any given month are sometimes charged as a percentage of the outstanding amount.
    4. Different banks charge different interest rates, and have their own penalty charges.
    5. Without a monthly income or an absolutely guaranteed source of funds, managing credit card debt is literally impossible.

    Two months down the line Mr. Babu got another job, still reeling from the fact that his savings could only get him the basic necessities like food and somehow manage to cover his rent. He was also constantly being bombarded by calls from the 6 banks and their recovery agents requesting and sometimes threatening him with consequences if he didn’t repay the debt.

    Even though he had a steady job with a monthly income again, he ended up owing way more than he had borrowed thanks to penalty interest and charges. His debt was now close to Rs.5 lakh, and it was only increasing because his monthly payments were only covering the interest and penalty interest portion of the monthly charges – for all 6 banks. All his earnings were only going towards paying off interest and not the principal outstanding on which the interest was being charged. It was as though he was running to stay in the same place.

    A few hours with a calculator on a gloomy Saturday evening helped Mr. Babu realise his mistake – he was paying off 6 different types of debt for 6 different cards with 6 different interest rates and 6 different penalty rates. And he also realised that even if he continued making payments the same way for another 10 years, his principal outstanding amount would still be the same, as he was only paying off the monthly interest that keeps coming back. That’s when he decided to opt for debt consolidation.

    He approached a bank and took out a personal loan for Rs.5 lakh, which he used to pay off and close all his credit cards. All the debt was clear from 6 different places and was now channelled into one loan. 6 credit card debts became 1 loan debt. He had successfully consolidated his debt under one single heading.

    There are many benefits to debt consolidation (using a personal loan to pay off all your debt):

    1. Lower rate of interest: Personal loan interest rates are among the highest of any loan category, but are still lower than the average rate of interest on credit cards. The actual interest Mr. Babu was paying (including penalty interest) for his 6 cards was around 40% on average, but his new personal loan only charged him 18% interest annually. Not only was this a huge relief from paying an overall larger amount out of his own pocket, but it was easier to manage and calculate as he only owed money to one bank and not 6.
    2. Tenure options: Personal loans, unlike credit cards, allow you to choose the duration of the repayment tenure. In Mr. Babu’s case, he was unable to repay his Rs.5 lakh outstanding loan in 1 year, so he opted for a comfortable 3 year loan tenure in which he would easily be able to make small monthly payments and eventually clear off all his debt. Credit card purchases allow a certain amount of control over the tenure of the repayment, but not as much flexibility as a personal loan.
    3. EMI options: Directly related to the flexibility in choosing the tenure, personal loans also offer the flexibility to choose and EMI amount that’s affordable. Picking the right EMI amount is almost as important as the planning that goes into taking the loan in the first place. EMIs should never exceed 40% of the total monthly income in order to enable a sustainable life for the borrower. In Mr. Babu’s case, he opted for a smaller EMI but a longer tenure in order to clear out his debt with minimal tension.
    4. CIBIL and other Credit Information Companies (CICs): Credit Information Companies like CIBIL are the resource that all banks and lenders refer to before approving or rejecting loans. There are many factors that affect CIBIL scores, but basically all you need to know is that responsible financial behaviour like paying of dues on time, honouring EMI payments, etc. contribute to a strong CIBIL score. People with lower CIBIL scores have a tough time getting loans approved, as the bank has no evidence that the applicant can be trusted to repay his / her loan. Because of this, banks charge higher interest rates to applicants with lower CIBIL scores but these still won’t be as high as credit card interest rates.
    5. One source of debt: Owing money to 6 different lenders is very difficult to manage and keep track of. One of the most important benefits of debt consolidation is that a person in debt can bring all his outstanding debt under one source. Instead of owing Rs.1 lakh to Bank A, Rs.2 lakh to Bank B, Rs.50,000 to Bank C, Rs.70,000 to Bank D, Rs.30,000 to Bank E, and Rs.50,000 to bank F – you can just choose to owe the total of Rs.5 lakh to Bank Z at one set rate of interest, and clear this off in a systematic manner. It’s always better to minimize the number of parties involved in any debt related financial scenario, as it helps maintain transparency and clarity in the entire process from borrowing to repayment.

    Mr. Babu was fortunate enough to be able to escape his credit card debt through debt consolidation by taking a personal loan. But sadly this concept is still viewed as “taking on debt to clear debt” and the facts in terms of numbers are ignored.

    *Please note that all promotions, amounts, tenures, repayment requirements, time frames, interest rates, other rates, charges, fees, ceilings, requirements, criteria, features, benefits, exclusions, calculations, ratios, averages, ratings, terms and conditions mentioned above are as of July, 2016, and are subject to change at any time. All banks / NBFCs / insurance providers / financial service providers / companies, etc. mentioned above retain all rights to modify, replace, or add to or subtract from any of the above, in any way, at any time, and at their own discretion. You are requested to reconfirm the same with your chosen bank / company / NBFC / insurance provider / financial service provider, etc. before making any financial commitments.

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