How to Manage Loans When Your Salary Stops

In an ideal world we'd all be loan-free. In reality, most of us have some loan running, and repaying it becomes very hard once the salary stops. Here are the practical steps I'd follow.

Good loans and bad loans

Good loans help you build an asset: an education loan, a home loan, a loan to start a business. Bad loans pay for wants: personal loans, vehicle loans, holiday loans, credit card debt. The plan is simple: close the bad loans as fast as possible, and restructure the good ones.

Step 1: list everything

Write down every loan, the amount outstanding and the interest rate. Then group them into good and bad. Bad loans almost always carry the higher rates.

Step 2: clear the bad loans first

There are two well-known methods. With the snowball method, you clear the smallest loan first. With the avalanche method, you clear the highest-interest loan first.

Say you have three bad loans and can afford ₹40,000 a month towards them:

• Snowball: personal loan first, then the credit card, then the vehicle loan.
• Avalanche: credit card first, then the personal loan, then the vehicle loan.

Avalanche saves more money. Snowball gives you quick wins that keep you going. With credit card interest this high, I'd always clear the card first.

Step 3: consolidate credit card dues

If you owe on several cards, move the balances to the one with the lowest rate, or to a balance-transfer offer. One payment is easier to manage.

Step 4: restructure good loans

Talk to your lender about restructuring your home or education loan so the EMI comes down or you get more time. Do it early, before you miss a payment.

Where the repayment money can come from

• A loan against your Provident Fund, or a partial PF withdrawal, to clear high-interest debt
• A loan against Sovereign Gold Bonds, shares or mutual funds, usually at a lower rate than personal loans
• A Systematic Withdrawal Plan (SWP) from your mutual fund corpus for monthly income
• A cheaper loan to close an expensive one
• Money set aside for a foreign holiday, a new car or a new phone
• After those, children's marriage savings, and only then their higher-education savings. Education can be funded with an education loan later if needed; a wedding can be sized to your situation at the time.
• For those over 60, a reverse mortgage: the bank pays you a regular amount against your house while you keep living in it, and the loan is settled from the house later, unless your family repays it.

Rules I wouldn't break

• Close bad loans first, using the steps above
• Keep your emergency fund and severance aside for living expenses for the next year, or until you have a new income
• If you start an SWP, keep withdrawals small enough that the corpus isn't eaten up, and remember that inflation keeps raising what you need
• Don't touch your retirement savings unless it's a real emergency