Limit household loan EMIs to 30-40% of your income to manage finances wisely for the future
borrowing bad? Doesn’t debt oil the financial machinery of the world? Why do personal finance columnists like me dissuade households from borrowing? These questions arose from feedback to last week’s column.
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Let’s begin with the other side of the argument. The most popular way to build assets is by borrowing. This is called financial leverage, and every Finance 101 class teaches this simple concept. On the one hand, there is an asset that is expected to grow in value, say 12% per annum. On the other hand, there is a market for borrowing that is willing to lend money at 10% per annum. It is easy to see that one can borrow at 10% and invest in the asset at 12%. Voila, the asset has been funded with someone else’s money.
However, in reality, there are many complications. The lender will ask for interest to be paid at a certain rate, periodically, but there is literally no asset—yes, it’s true—that is capable of appreciating at a certain rate every year, and staying above the borrowing rate at all times. All assets come with risks. Therefore, lenders won’t fund an asset completely, but ask you to put in your money (called equity) before lending theirs. The risk of fluctuation in value is all yours.
If you end up with a great asset that grows in value, and if you put in only a portion of your money, borrowing the rest, the return on your investment is
