Are you in a virtual debt trap?

Have you ever been in a situation where you have savings to buy something, but choose to buy it taking the loan/ EMI route?

If the answer is NO, you are hopefully taking a right approach towards your financial life.

If the answer is YES, then you are in a virtual debt. And you are not alone.

What is virtual debt?

virtual debt - buying on loans and EMI

It is being in a state where you have a debt which can be taken care of by your savings, but you choose not to.

In other words, you are in a state of debt while your net financial condition indicates otherwise.  It is different from being in a case, where you take loan/ EMI because you are short of funds.

The reason for being in virtual debt can be many – “promise” of returns higher than the interest rate you are paying, discomfort on seeing your savings dip below a certain level, tax benefits you may be getting or plain laziness, wherein you find it too cumbersome to evaluate the pros and cons of EMI.

More often than not this debt is avoidable.  However, you need to think for yourself if being in virtual debt is good for you or not.

Examples of virtual debt

  • Taking a personal loan for a foreign vacation (say Rs.  200,000/ $3000 personal loan @ 12% per annum interest) and hoping that the same amount in your mutual funds will give “Assured” 15/ 20/ 25 percent annual returns. (May or may not happen!)
  • Taking a loan for repairs in your house but not touching your equivalent savings, because that is your contingency fund and you need to have access to it at any given point of time.  (while it is good to have a contingency fund, you decide for yourself it is prudent to take a loan in this case – maybe, or maybe not!)
  • Buying the latest iPhone on EMI because – hey, it is available in easy EMIs! (Huh!)
  • Defaulting on your credit card bill because you  don’t have enough in your savings account and you don’t want to break your fixed deposits!

(You may also be interested in – worst debts and loans that you should avoid)

What are benefits of virtual debt?

While debt is usually avoidable, there are cases when one may find is beneficial to take debt. (To each their own!). Here are some possible benefits in these cases.

  • You may keep your contingency fund untouched, which may be helpful in case of any unforeseen emergency
  • In few cases, the rate of interest you get is lower than rate of returns on your investment (Unlikely, but possible. And I am not including “assured” 15 or 20 or 25% “promised” returns from stock markets in this)
  • In some cases it may give you tax benefits – e.g. home loan/ education loan

What are drawbacks of virtual debt?

  • You end up paying more than the cost, thanks to interest you pay.
  • More often than not, the debt is for something that is avoidable – e.g. upgrading your car, buying a high end smartphone or any other gadget, taking a luxurious vacation etc.
  • Taking debt can soon become a habit. And before you realize, you are in a perpetual EMI trap (until you take efforts to break this EMI habit, and it is not easy to break this habit)

(You may also be interested in – Assumptions in managing your investment and finances)

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Usually, virtual debt is something to be avoided, but in some cases it may be helpful. So, do your math and evaluate for yourself if such debt does any good to you.

Have you taken a debt when you could have avoided? Maybe, you need to rethink if being in a virtual debt is worth it …

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3 Comments

  1. I almost fell in this trap when I was buying my car. Not having saved up enough, i was tempted to take out a loan to bridge the gap despite having enough on my committed savings. After doing the math, i realised that it will be cheaper to draw from a committed investment rather than taking a loan. Now i am struggling with the same thing, should I take out money and put up an upfront deposit to my house?

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