Cutting out the debt: Credit card dues first

Arnav Pandya/ETIG, TNN Jun 3, 2005, 12.44AM IST

Keeping the finances in order is a problem that most women are confronted with. Hence, they rearrange their income and expenses for financial planning. But apart from investments, there is a need to consider the other side of the equation, too, because borrowings have become common with most people.

One of the problems, while starting new investments on a regular basis, is the cash crunch. Even if the required amount of cash is available, then the next question that confronts most women is whether this should be used for the purpose of investment or to pay off the debt.

There are no readymade answers to this as the situation could vary from individual to individual depending upon their specific circumstances. However, there are some broad guidelines that one could follow with respect to the debt part.

The first issue is the nature of the debt and the extent of liquidation that is possible with the available resources. A clear distinction has to be made between debt used for the purpose of creating assets and those used to finance some expenses.

Some of the debt are for long term like a housing loan or a car loan. Then there are other outstandings in the form of short term obligations that need to be tackled quickly. These include personal loans or short term loans and credit card repayments.

Many people have large amount that are outstanding on credit cards. These cards are easy to use and convenient, but at the same time it calls for a great amount of discipline to ensure that one does not get caught in the high interest trap.

People try lot of things to postpone the interest burden. Sometimes, the outstanding are changed from one card to the other in order to get temporary relief due to the provisions relating to balance transfer. But, ultimately the interest burden catches up at some point of time and the results can be disastrous.

Paying off these amounts should be the first priority of any individual. There is just one simple calculation that one needs to keep in mind. This is the actual interest rate that they end up paying. The interest that a person pays on a credit card roughly amounts to anything between 30-44% depending upon the rate that is being charged from them. There are very few other borrowings that will entail this kind of interest.

Further, there is no way in which any other kind of investment would ever generate such kind of return on a consistent basis. In the light of such a situation, the decision about what to repay should not be too difficult to make.

Hence, one would be better off keeping a strict eye on the credit card outstanding and then ensuring that the amount is settled on the expiry of the the credit period. But, the main question is: how does one go about this entire process?

First thing that a person should do is to make a list of all the outstanding or loans. These should then be classified according to their nature and the interest rate that is charged on them. Once this is done, the interest rate figure has to be brought on a common level and this is possible when it is converted to a per annual basis.

This exercise will show the outgo that one is being charged on the various borrowings. After this, the order of priority should not be difficult to calculate and one would come to know which are the ones that need to be paid earlier. It would be better if the individual ensures that investment and the repayments do not become a mutually exclusive affair.