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How to manage interest income, expense

Ashish Pai / Mumbai 05 Aug 12 | 12:36 AM

Interest that you earn on investments may not be a substantial portion of your income initially. But as you stay invested for longer, it starts playing an important role especially for those near retirement. Keeping a tab on interest expense is important for wealth generation. Though we don't pay much attention to it, but managing interest income and expense, is very important for proper financial planning.

Most of our primary source of income is salary or professional fees or business income. Apart from this, we have other sources of income (called other income in tax parlance), which mostly constitutes interest income for individuals. In the initial part of your work life, this forms a small percentage of our total income. However, as your income and savings increase over time, so does your interest income's share in total income.

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Most of us, save through bank deposits or Post Office instruments. And the savings that are accrued over time help you to build a corpus to serve your retirement needs. Hence, earning higher interest income should be the objective. Lets see how you can do that.
 

INCOME SHEET
Instruments  Tenure
(years)
Interest
Rate (%)
Benefits
Bank deposit  3 9.25 Interest compounded quarterly
Post Office deposit 3 8.40 *

-

PPF 6 8.8* Tax-free interest
EPF - 8.25# Interest is tax-free
Bonds - 10-10.50 Carries risk of liquidity 
Company deposits - 9-10.50 Risker than bank deposits
GoI bonds 6 8 Carries risk of liquidity 
Senior Citizen  Scheme 5 9.3* Carries risk of liquidity 
*w.e.f. April 01, 2012,  # For FY11-12
 
EXPENSE SHEET
Type of loan

Interest rate (%)

Home 

10.25-11*

Car 14-Dec
Personal 14-Dec
Education 14-Dec
Credit

18-20

*Banks’ floating rate

The interest income can be earned through fixed income instruments. Although fixed deposits are the most popular instrument, there are others also such as Public Provident Fund (PPF), bonds, company fixed deposits, senior citizen savings scheme, among others. All these instruments have varied risk and liquidity profile.

Earning a better rate of interest: The interest income can be optimised by putting money in better interest earning instrument(s). Always look for investment avenues which give a better yield. For instance, presently the returns provided by company fixed deposits is much higher than the bank deposits. Companies like HDFC are paying 9.25 per cent for one-year and Mahindra & Mahindra is paying 8.50 per cent.

It makes sense to lock in your funds in such instruments. But, do remember that these are more risky than bank deposits. Therefore, it is for those willing to take some risk for higher returns.

Do not keep funds idle: Always deploy funds in such a way that there is adequate liquidity available at hand while you continue to earn reasonable returns. Like, say you have funds but don’t not need it immediately. You can either park this money in small tenure fixed deposits or in debt mutual funds. Look at the interest you earn. State Bank of India's one-year deposit will pay 7.50 per cent, six and three-month deposits will pay 7 per cent each. Ultra short-term debt funds have earned 9.50 per cent in one year, close to 5 per cent in 6 months and 3 per cent in 3 months.

Staggering deposits: Here, you need to spread the deposits you will make over several years so that each deposit matures at periodic interval rather than in one go. In this way, the depositor reaps the benefits of the spreading the maturity amount over a period of time and thereby spreading his interest rate risk and also having adequate funds in hand.

Tax woes: Invest in instruments which are tax efficient like tax-free bonds, PPF. Here, you earn and at the same time don’t get earnings eroded.

In order to build assets or finance an event, funds are required. If you need a huge corpus, you may need to borrow like for buying a house / car / consumer durables, children education or marriage, vacation and so on. To borrow you should be ready to repay the principal and interest. A typical borrower, now a days, is aged between 28 and 40. The interest outgo is an expense for the borrower and proper management of the same is crucial. Today, higher standards of living has given way to the need to borrow funds for purchase expensive asset(s) from financial institutions. Here’s how you can manage interest expense.

Lower interest expense: One of the best ways to reduce your borrowing cost is to fund you expenses through internal resources as much as possible. By doing so, you can reduce your cost and of borrowing by a good margin, depending on the percentage of self funding you can provide.

Loan terms: Before entering into a loan agreement, analyse the terms and conditions given. This is a must to avoid hidden cost(s).

Repaying dues on time: This will help you avoid additional interest cost and penalty on the ongoing repayment. Also, non-payment can land you in credit bureaus' defaulters list. This, in turn, can lead to lenders refusing to lend you money in future.

Loan prepayment: One of the best ways to save money or reduce loan cost is to repay as soon as you can. The longer you take to pay off the principal amount (called prepayment) the long you may have to repay sometimes even higher interest may be charged, increasing the overall loan cost. So, plan prepaying your loan sooner. Even the government rewards you for the same by allowing a deduction of up to Rs 1 lakh for principal repayment every year.

Loan transfer: In case you feel that the borrower is charging you a higher interest you may transfer your loan balance to another bank offering a lower rate, also called refinancing. This also makes sense because now banks do not charge prepayment penalty.


 

The writer is a freelancer

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