“What can be measured, can be improved.” – Peter Drucker

If you draw a salary, you tend to have a regular credit to your Bank account of roughly the same amount each month. In contrast to this inflow, you face a multitude of expenses that debit your Bank account, the timing and value of which may be uncertain. Consequently, while all of us may know how much we earn at the start of the month, our estimation of what is left over at the end of the month would be fuzzy. What we are even less sure of, is the nature of spending done through the month. While some debits from our Bank account may be building our assets (E.g., Investments in capital markets or payment for a home loan EMI), some others will be consumption related (E.g., groceries purchased or loans repaying depreciating asset purchases). One of the keys to accumulating wealth is to maximize investments and minimize consumption. To distinguish the debits from our account into these two categories, desirable and undesirable, it is essential we track our expenses on a frequent basis.

The primary benefits of tracking expenses are:

1. You gain an understanding of the volume, timing and categories of your money outflows and can therefore optimize or reduce some waste that you can identify on an analysis of your spending categories
2. You shine a light on expenses that are not monthly, such as car service, insurance payments, etc.
3. You can match your inflows and outflows, and arrange your finances to have money waiting when bills fall due
4. You can systematically increase the proportion of your salary that goes into investments once you have arrived at your investment/ savings rate

Traditionally, expenses used to be tracked with spending logs that had to be then tallied up at the end of a month. The advent of technology has enabled us to automate this activity and have a convenient analysis in the palm of our hands at any time of our choosing. There are many apps which track, categorize and summarize our spending for us available for free these days.

I have an Android phone, and one such app I personally use to track my personal finances is Walnut. The app reads SMS messages, remembers past transactions, categorizes transactions and can also provide downloadable excel files of all my expenses for any time period of my choosing. The iPhone version of the app does not have permission to read SMS, so I believe this app is of limited utility for iPhone users.

I would recommend the following considerations at the time of tracking expenses

1. Smartly bucket your spending. Having too few (or too many) categories may mask wastage and prevent you from generating actionable insights to optimize your spend
2. I recommend two categories for your asset accruals as well – Home Loan EMI and Investments. While 100% of your investments goes into building your assets, the home loan EMI amount is split into a principal component and an interest component.
3. You should target that the spending on your asset accruals should total up to at least 50% of your cash inflows. If your investment proportion is currently less than that, it is essential to have a plan to reduce consumption expenses so that you are hitting the 50% mark within a realistic timeframe. I would consider this 50% as a watershed mark, as this roughly means that for every year of working you are accumulating assets that allow you at least one year of free time.

Lastly, this act of tracking expenses would also set forth a virtuous cycle where you constantly seek to optimize your spending and investing to bring the countdown timer to your financial freedom closer to zero.

To optimize the debt payoff journey, it is essential we realize the following aspects:

Interest/Principal Proportion

Interest accrues on the balance outstanding at any point in time. As the balance outstanding at loan start is higher than towards the end of the loan, most of your Equated Monthly Instalment (EMI) at the start of the loan accounts for interest and only a small portion goes into repaying the principal. Over time, as the principal balance reduces, interest accrued on outstanding amount reduces and therefore, a greater amount of the EMI pays off the loan principal. Thus we can note that the loan balance depletes slowly at the start of the loan and gathers pace as time goes on. That makes it in the Bank’s interest to keep the borrower in the first half of the repayment schedule, where the interest payment proportion is high, rather than the second half when less interest is accruing.

Lumpsum Payments

To minimize interest paid during the life of the loan, you should repay lumpsum amounts towards principal as and when you come across additional money. In case of salaried employees, one of the best uses of the annual bonus payout is to throw it at the loan, as this repayment is a guaranteed return of your current EMI rate. The balance outstanding is reduced, bumping up the interest portion of the EMI, while also reducing the interest accruing daily as the balance is smaller.

Stepping up your EMIs

In addition to periodic lumpsum payments, the borrower should also aim to repay the loan faster by stepping up the EMI amounts. Any increment in your salary should also increase your EMI amount by at least the same proportion. This also has the benefit of reducing the cashflow into your account, thereby preventing lifestyle creep.

Never-ending loans

If the amount paid by a borrower on a monthly basis is LESS than the amount of interest accrued on the outstanding amount for that month, the loan is in “Negative amortization”. 100% of the amount paid goes to the interest and the amount of interest in excess of the amount paid is added to the principal outstanding. The loan balance increases and your loan is never repaid. It’s therefore essential to ensure that at a minimum the EMI amount exceeds the interest accrued from day 1 of the loan to prevent the borrower from being ensnared in a debt trap.

Impact of changes in Interest Rates on Loans

The interest rate may be either fixed or floating. Fixed interest rates do not vary over the duration of the loan, while floating rates are reset on a periodic basis (say quarterly) in line with an agreed upon benchmark. In India, Banks currently use the Marginal Cost of Lending Rate (MCLR) to determine the interest rate of the loan. The amortization schedule automatically adjusts the interest and principal component of each repayment to a changed interest rate, so any variation in the interest rate reflects in a change in the end date of the loan – A reduction in the rate reduces the number of pending instalments, while an increase in the rate adds more instalments to the end of the schedule. While the borrower does not feel the impact as the same amount is debited from his account every month, he will be in debt for longer or shorter on the basis of the upward or downward adjustments in the interest rate.

Let’s start off with a basic understanding of how debt is paid off. While the concept is pretty simple, it’s surprising that this is not common knowledge. A clear idea of how debt accrues and is paid off is useful to take control of the debt repayment strategy that works best in your interest.

Amortization is a method to calculate the repayment of a loan over time. From the day you borrow money from a lender, the lender accrues interest on the amount outstanding. A portion of every repayment goes into repaying the accrued interest and the remaining amount of your instalment reduced the principal, or loan amount left to pay back. An amortization schedule is drawn up for a monthly repayment amount at an agreed upon interest rate. This amount is usually a regular monthly amount (Also called as EMI or Equated monthly instalment), so the borrower can plan for arranging the agreed upon amount on a monthly basis.

Amortization schedules are easy to generate on an excel sheet, and we also have many versions online. A basic skeleton of an amortization schedule is as below:

Date	Principal (Month Start)	Annual Interest Rate	EMI	Interest Accrued	Principal Repaid	Principal (Month End)
01-Jan-21	1,00,000	12%	1,500	1,000	500	99,500
01-Feb-21	99,500	12%	1,500	995	505	98,995
01-Mar-21	98,995	12%	1,500	990	510	98,485
01-Apr-21	98,485	12%	1,500	985	515	97,970
01-May-21	97,970	12%	1,500	980	520	97,449
01-Jun-21	97,449	12%	1,500	974	526	96,924
01-Jul-21	96,924	12%	1,500	969	531	96,393
01-Aug-21	96,393	12%	1,500	964	536	95,857
01-Sep-21	95,857	12%	1,500	959	541	95,316
01-Oct-21	95,316	12%	1,500	953	547	94,769
01-Nov-21	94,769	12%	1,500	948	552	94,217
01-Dec-21	94,217	12%	1,500	942	558	93,659
01-Jan-22	93,659	12%	1,500	937	563	93,095
01-Feb-22	93,095	12%	1,500	931	569	92,526
01-Mar-22	92,526	12%	1,500	925	575	91,952
01-Apr-22	91,952	12%	1,500	920	580	91,371
01-May-22	91,371	12%	1,500	914	586	90,785
01-Jun-22	90,785	12%	1,500	908	592	90,193
01-Jul-22	90,193	12%	1,500	902	598	89,595
01-Aug-22	89,595	12%	1,500	896	604	88,990
01-Sep-22	88,990	12%	1,500	890	610	88,380
…
…
…

For floating rate loans, the interest rate changes on a periodic basis (usually quarterly). Consequently, the schedule could incorporate calculations by varying the interest rate for particular months.

Prepayments, in India at least, are applied to the principal outstanding. So, if the borrower approaches his lender to prepay a certain portion of the loan, the amount reduces the principal so the interest accumulating monthly jumps downward.

What can be measured, can be improved. An amortization schedule allows the borrower to project the loan into a series of cash outflows from his account during the years that follow. This enables appropriate planning of the future – examining the impact of changes in interest rate, planning for prepayments and also for increasing the EMI – with an approximate view of how the loan repayment will be modified by factors within and outside the borrower’s control.