Personal loans or any other loan products are an inevitable part of most of our lives. But you need not reel under tremendous pressure of repaying the money over long periods. The article presents a simple strategy to reduce your long term payments and turn it into investments.
If you take out an AED 100,000 loan for 4 years at 6% interest, how much in debt are you?
Some might argue that you’re only AED 100,000 in debt. However, if you look at the big picture, the total amount payable by you will be AED 124,000 if the interest rate is fixed or AED 112,729 if the interest rate is calculated on reducing balance. This is considering that there is no processing fee and other charges.
You see what is the difference?
Now if you calculate your net worth, you might end up being in the negative region if you do not have substantial savings and other assets and that is a very scary situation for anyone.
So, now you’re AED 124,000 in debt. You are going to make a monthly payment of AED 2,583. Keep in mind that this payment is for 48 months. Now, arrive at the total figure payable by you, you could multiply the monthly instalment with the number of months. And the amount is roughly AED 123,984.
Let me give another scenario. Suppose, you are to reduce the number of repayment months by 12 months ie to 36 months, you will be paying a total of AED 118,000 that is a straight decline of AED 6,000.
See, the lesser the tenor of the loan or the finance, lower will be your total repayments.
Every time you add a little extra to the payment, the total payment amount you’ve agreed to play goes down. Your obligations are reduced for the future. Not only that, you get the extra money you added back at the end of the debt in the form of a smaller final payment.
I have personally used the calculators I prepared (CLICK HERE for REDUCING BALANCE CALCULATOR) and Bankrate for the ease of the use and their usability.
Why think of things this way? For me, there are really three reasons that stand out for looking at debts this way.
One, this method makes it clear how much you’re actually obligated to pay. An AED 100,000 debt doesn’t mean that you’re obligated to make AED 200,000 in payments. It means you’re obligated to make quite a lot more.
Two, it’s very clear how much of a positive impact early debt payments can make on your future obligations. The impact is large. Thanks to calculating things in this way, one can really see the big impact extra debt payments make to one’s future obligations.
Three, it lets you see how powerfully debt repayment compares to investing. Early debt repayment doesn’t have a powerful impact on your financial bottom line unless you invest the money somewhere else. In fact, it has no impact for the time being – it only shows up very gradually as future payments begin to take advantage of the lowered principal and less of your payments go toward interest. An investment, on the other hand, can quickly begin showing returns that directly show up on your personal balance sheet.
If you do use this method, though, you can quickly see the long-term impact of an extra debt repayment on your bottom line. Your obligations are immediately lowered by that extra payment, which lets you breathe easier.
For me, things have to be very clear from the beginning. The total obligation or the full payment is what I have in mind rather than the loan amount. Availing personal loan and other loan products are inevitable for most of us.
We must remember a thing, quicker you repay the loans, better for our future. Instead of paying higher interests to the banks the same money can be invested somewhere fruitful.