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It is important to keep track of your assets and investments and how they are performing and how far they are helping you in achieving your goals but it’s equally important to keep a check of your liabilities. Your cash flows at any point in time will be greatly impacted by the way you manage your liabilities.

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Let’s broadly classify liabilities into two parts to make it easy for us to understand.  Your ongoing home loan, car loan, education loan or your personal loan could be one type of liability. Your pending credit card bills or any other kind of unpaid bills could be the second type of liability.

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Let’s talk about the second type of liability first. There is a very high interest rate that they charge on the unpaid credit card bills. It is important to get rid of these as fast as possible. The amount will multiply much faster than you realize and you will get into the loop where you will pay of a part of it and by the time you decide to pay the rest of it already a huge interest might just get added to it. In short it leads to drain of wealth of an amount much higher than your original liability. Another important implication of this is on your credit scores. Every individual who has ever taken a loan has a credit score. This depends on your financial behavior and the way you service your existing debt. Going forward the debt score will determine your loan taking ability and the rate you will be charged for the same.

The other type is your home, personal, car, education loan, etc. Most commonly people have either a home loan or a car loan. The way you can manage them will depend upon the rate of interest that you have been paying on your existing loan and what are the current loan rates in the market. If there is a scenario similar to the current one where there is an expectation of further rate fall then you should take a new loan at a lower rate to repay your existing loan where you may be paying a higher rate.

If you have some goals, so you can choose to pay either higher EMIs or lower EMIs depending on the need for cash flows at a particular point in time. In any loan the EMI that you pay services your interest portion in the beginning and then slowly it starts servicing your principal component. Therefore you might notice after few years of regular EMI payment your principal may have reduced by a very small amount.  If you have a surplus cash inflow at any point in time then you might want to prepay some part of your loan. Its appraisal time now in some of the organizations. If you receive a salary raise then you might choose to pay a higher EMI to speed up your loan repayment.

If the rate of return on the investment is higher than the rate of your loan then you should consider investing instead of prepaying. But if it is the other way round then you should consider prepayment.

Also recently Marginal cost based lending rate (MCLR) has been introduced and is applicable from 1 April 2016. The MCLR linked loans are at least 0.10% cheaper than base rate linked lending rates. Only floating rate loans can get linked to MCLR. It has a reset clause which means your rate will get reset on every reset date. Reseat date depend from bank to bank. MCLR rate is calculated based on deposit rate of the respective bank plus a spread instead of base rate as it was done earlier. At every reset date when your rate changes it will alter your loan tenure and not your EMI. But if you want a change in EMI you can inform the bank. The new loan applicants will get loans linked to MCLR Rate. The existing investors can also shift to this rate by paying a fee. Most banks are charging close to 0.5% fee. So if there is a difference of at least 0.25% in the rate that you are paying currently and the new MCLR rate then only you should consider switching.

Last but not the least,

Don’t just keep paying EMIs. Take a look at available cash flows, need for cash flows and your goals and then decide how you want to manage your liabilities.

 

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