Which loan should you get rid of first? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Which loan should you get rid of first? 

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In this issue:
» Can a coal regulator be effective in India
» Should you write off Nano?
» Metal firms facing the heat
» Eurozone nearing another recession
» ...and more!

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Multiple credit cards. A home loan. An auto loan and an education loan. Welcome to the world of a typical urban Indian. The word credit and loans is integrated with his life. Hence when interest rates spike up and income levels do not follow suit, the urban Indian is naturally worried. And then he decides that it is best to repay some of this loan. But the big question that haunts him is which loan to repay first? If you face a similar situation, then you would find it interesting that Economic Times has tried to help you with this dilemma.

In a recent article, the publication has tried to help its readers in working out a process of loan repayment. The first instinct that we as debt payers have is to repay that loan which is of the highest denomination. This is usually the house loan for most of us. But this is actually a wrong way of going about things. As per the daily, the best thing to do is to rank your outstanding loans by the interest burden that each carries. The next step is to first repay those that carry the highest level of interest. At the same time it is equally important to understand the tax aspect of each loan. Some loans like home loans help in getting a tax benefit. Therefore the effective interest rate on the same should be adjusted for this benefit.

As a result, one would realize that the loans that carry the highest level of interest rate are usually the credit cards. With an effective rate of nearly 36% it is the most expensive loan and therefore deserves to be repaid first. Personal loans and car loans follow thereafter while home loans and education loans rank the lowest.

While it is good to reduce debt burdens particularly during tough times, it is important for all to remember one thing. Tough times solicit the need for having a cushion of savings. This is the cushion that helps one in tiding over the bad times. The quantum of savings that one can keep differs from individual to individual and financial planner to financial planner. In our opinion one would do well to remember the rule of 9-9-9. Paying off all loans that carry over 9% interest rate; save 9% of your income as retirement and yes, have at least 9 months of necessary expenses as savings. The balance can be used to reduce the debt burden. After all with inflation spiraling upwards your household budget is already under strain. There is no point adding to it in the form of higher interest burden as well.

Which loan do you think should be repaid first? You can also share your comments with us or post your views on our Facebook page / Google+ page.

01:05  Chart of the day
Once upon a time, the natural progression for all graduates was to do a post graduate course. And the normal choice of course was the MBA or Masters in Business Administration. It was the ticket to getting the optimum education required for the coveted high paying jobs. But in recent times, the glamour of an MBA seems to be losing its touch. As shown in the chart, the number of MBA aspirants enrolling for the Common Admission Test or CAT has started to dip down. One reason behind this waning interest is the oversupply of management graduates. With a management institute in every nook and corner, the number of graduates being churned out has shot up dramatically. At the same time, the number of jobs available for them has remained the same. In a competitive world, the best quality of education has triumphed. As a result, many graduates from Tier B and C institutes have been left out of the job circuit. The need is to revamp the system and the regulator to wake up. Granting a license to everyone does not really help. Instead it would be better to improve the quality of education being given by the existing institutes.

Source: The Mint

Why do critical sectors in an economy have regulators? The purpose is to have an independent authority to protect the interests of all the stakeholders. Reserve Bank of India (RBI), Securities and Exchange Board of India (SEBI), Insurance Regulatory and Development Authority (IRDA), etc are some major Indian regulators. Yet there are some crucial sectors in the economy that continue to sway to the tunes of various ministries that influence them. The coal sector is one of them.

The need for a coal regulatory authority was first noted in the Union Budget 2007-08. The government is working on the same. The Bill is currently in draft stage. However, the coal regulator is unlikely to be a powerful regulatory body. At most, it would be a routine approving authority. Why so? The reason being that the various ministries involved are unwilling to hand over control of important executive powers. One is coal pricing. The other is power to authorise mining. With these two major aspects likely to remain under government control, there will not be much on the table for the regulator.

After a disappointing first quarter (1QFY13), Indian metal companies are poised for another tough quarter. This is due to rising fuel costs and lower prices of finished goods. Global commodity prices particularly that of iron ore, have been coming down. Iron ore prices have fallen by about 28% so far this year. However, Indian steel manufacturers could not benefit from the drop in international iron prices due to sharp depreciation of rupee against dollar. Steel prices have also declined sharply. The sharp correction in global steel prices has been due to a slowdown in demand in European and Chinese markets.

Between July 1 and August 24, steel prices declined by 23%. The slowdown in automobile and real estate sectors has also hit steel demand. With no major infrastructure investment taking off, steel demand is likely to remain under pressure. Sluggish demand has led to inventory built up for steel producers like Steel Authority of India Ltd., JSW Steel and Tata Steel. Besides this, the second quarter remains seasonally a weak quarter for metal sector due to the monsoon season. As a result, profits of metal companies are likely to face more heat in the forthcoming quarter.

Business history is replete with innovations and products that were touted to be the next game changers. But once they sunk their feet into the waters of reality, they turned out to be nothing but colossal failures. Can you think of any recent product in India that stands up to such a demeaning description? If Firstpost.com is to be believed, Tata Nano may perhaps fit the bill. Of course, colossal failure may be too harsh a word to describe the journey that the diminutive Nano has had so far. But it can't be denied that it hasn't met with the success that was expected of it when the idea was first conceptualized.

So, what possibly could have gone wrong? We believe that the biggest reason the car failed to live up to expectations is the public perception of it. The innovators were under the impression that an automobile is just a huge metallic mass that takes people from point A to point B. They perhaps failed to take into account the fact that it is much more than that. Above all, it is a status symbol that people like to flaunt and make their neighbours envious with. Obviously, a car positioned as being the cheapest around failed to live up to this tag. Thus, more than anything else, the Nano makers will have to get rid of this perception first if they are to have any chance of making the Nano super successful. Having said that, the task could prove to be a tall order indeed. It will be interesting to see what strategy they come up with.

With so many problems affecting the Eurozone, it is hardly surprising that the region is headed towards another recession. A key manufacturing index (the Purchasing Managers Index) has fallen for the seventh straight month in August. Given that two consecutive quarters of declining GDP signals a recession, the Eurozone appears to be heading that way. Output has declined in both the manufacturing and services sectors. Plus incoming new business orders have fallen for the 13th month in a row.

Indeed, massive debt in European countries such as Spain, Italy, Portugal, Greece has left the Eurozone tottering on the edge. So far, bailout measures not surprisingly have not really helped. And although Germany has fared better than its peers, growth in that country may not be sufficient to improve the fortunes of the entire region. Thus, unless European governments come up with some entirely new and meaningful way to solve various issues, we would not be surprised if another disaster were to hit the region.

In the meanwhile, after opening the day in the green, the Indian equity have dipped below the dotted line. At the time of writing, Sensex was down by 35 points (0.2%). Among the stocks leading the losses were Jindal Steel and Tata Motors. Other major Asian stock markets have closed the day on a mixed note with Japan and Malaysia closing in the green while China and Honk Kong closed in the red.

04:55  Today's investing mantra
"I think you have to learn that there's a company behind every stock, and that there's only one real reason why stocks go up. Companies go from doing poorly to doing well or small companies grow to large companies." - Peter Lynch
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4 Responses to "Which loan should you get rid of first?"

sharad sharda

Aug 28, 2012

Consideration is also required to the fact as to which loan is oldest one which might have lower outstanding dues but with a higher amount of EMI. By paying that loan, one can be able to have another loan of higher amount but preferably at lower rate with same amount of EMI. Moreover, in any case credit card dues in all cases deserve to be liquidated at once as it bear highest rate of interest. Liquidation of credit card dues can be effected even by recourse to personal loan which will definitely have a lower rate of interest.


Ramasubramanian C

Aug 28, 2012

Well while everyone wants to scale up his Balance Sheet year after year in the fond hope that our 8 % growth rate combined with the double digit inflation will pay for itself all the loans taken to build the assets - probably copied from the US. Thankfully, this approach is more with the urbanites and that too mostly with the techies. Trust this stops with them. Building assets with loans is fraught with great risk and borders on speculation which is suicidal.


sunilkumar tejwani

Aug 27, 2012

The India growth story is slowly dying and waning. No nation is an island in itself. Global economics are shrinking by the day. To compound and camouflage the issue, one broking house which has vested interest in Bharti Air tel, Bajaj , L& T is busy in organizing investment meet with various international investors, read speculators to sell his wares and to keep the respective share prices up. I lament upon this issue.


Umesh Sharma

Aug 27, 2012

It may look very tempting to obtain loans and a lead a lavish life style in an American way.But that is not quite the Indian philosophy.Any debt is a burden which is easy to obtain but very difficult to clear.There is no need to lead extravagant life by borrowing.We may have to compromise on our life style and cut down certain wants.But in the long run that would give us good health and sound sleep.The repayment of any future loan should be well within our resources and the asset we obtain should be worth it and provide adequate returns other than meeting our fancy.If we follow this policy we will never face the dilemma of which loan to pay first.

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