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What to Do When You Find Yourself in Too Much Debt?

If you find yourself in a situation where you feel like there is too much debt to handle and you need to get out from under the debt as soon as possible, there are some simple steps that will certainly help: 


Do Not Increase Your Liabilities If you find that you are already stretched, you may find that well-wishers are advising you to take another loan to pay off your existing loan. You would simply be delaying the time when you do have to sit down and pay off the debt. 


Do not add to your existing liabilities by taking on more loans. Once the existing liabilities are cleared, if you find that you need to take another loan – make sure it is easily serviceable by your existing, fixed monthly income, and the terms (tenure, rate of interest) are suitable to you. This should be done only after your existing liabilities have been paid off. 


Take Stock of Your Liabilities Maintain a Personal Budget. This simple and oft ignored tool is an excellent resource in your battle against debt and by maintaining a good personal budget, success against debt is achievable. 

A personal budget will help you discover the following: 


Your exact cash flows, your fixed monthly incomes and all your monthly expenses. Once you know your expenses, you can see where you are spending on luxuries – and rationalize this portion. Spend on the necessities only, save the rest. 


Calculate an approximate figure of how much extra money you can save each month – and allocate it towards a debt repayment fund. 


Your exact liabilities You can track exactly what debts you have and all their details. 


Create a table which contains all details of the various loans taken, loan type, each loan’s outstanding tenure, EMI, rate of interest and outstanding amount. The rule to be followed is pay off the highest interest rate debt first. 


Loans restructuring can be done in two ways. First, restructure your loan for a lower Interest rate. Second, refinance your existing high rate loan by taking a fresh loan at a lower rate.


Contingency Fund

Now, you need to assess your contingency (emergency) reserve. This should be 6 to 24 months of your monthly expenses, including EMIs if any. Hold this in a liquid mutual fund scheme. This should be used only in case of a financial emergency, which can occur at any time. Do not use this for big ticket expenses like contributing to a new car or a vacation. You never know when an emergency might occur and how much cash you will need. Think credit crunch year 2008.


Achieve your life goals with the right asset allocation


For this your financial planner has to take into account your risk appetite and tolerance, your cash inflows and outflows, your life goals and their priorities, your existing assets and liabilities, and create the optimal financial plan for you.


The outcome of the above exercise is asset allocation suited to you - how much to invest into each of the asset classes – equity, debt, gold and cash, and in which specific instrument, so that you achieve all your life goals like purchasing property, your children’s educations and marriages, your own retirement, family vacations and so on. 


Your planner will also ensure that as your goals approach, your goal corpus exposure is shifted from equity (unsafe, high risk) to debt (safe, low or no risk) instruments. This protects the corpus that you have built. Thus your equity exposure depends on the proximity to the goal and will be different for each goal that you have.


Follow your plan and remember to invest regularly into the markets, through ups and downs. Staying in the market is the key to successful long term investing. 


Make a Will


It is also prudent to have a Will in place. In case of your untimely demise, your Will ensures transfer of your wealth as per your wishes mentioned in the document, your beneficiaries get access to your assets without spending too much time and money. 


Beneficiaries get these assets either tax-free or pay tax at a lower rate than they would have paid in case of getting these assets without a Will. Also, they would have to run from pillar to post to prove their legitimacy thus spending lots of time along with money in case there is no Will.

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