Debt Management and Loans: formula sheet

Key formulas

Net worth

Net worth = Total assets − Total liabilities

Debt reduces net worth unless the asset it buys grows in value or income.

Borrowing test

Borrow only if expected after-tax return or benefit > after-tax cost of debt

Also requires that the client can service the EMI comfortably.

Good vs bad debt

Good debt: builds assets, income or lasting value. Bad debt: funds consumption, often at high cost.

This is a guide to judgement, not a fixed legal classification.

Debt service ratio

Debt service ratio = Total monthly EMIs ÷ Gross monthly income

A higher ratio means less room to save. Use the limit the question gives.

Secured vs unsecured test

Collateral present → secured; no collateral → unsecured

Home, vehicle, gold and loan against securities are secured. Personal loans and credit cards are unsecured.

Risk and rate link

Higher lender risk → higher interest rate (as a general rule)

Generally, unsecured loans cost more than secured loans. It is a general pattern, not a fixed law for every lender.

Loan-to-value (LTV) ratio

LTV = Loan amount ÷ Value of the asset pledged × 100

Used for home, gold and securities loans. Lenders lend only a part of the asset value. Exact LTV limits come from regulation and lender policy, so do not memorise one limit for all.

Credit card revolving cost

Pay full bill by due date → no interest on purchases (usual terms); pay partially → interest on the unpaid amount

Exact terms vary by card issuer. Read the question's stated conditions.

EMI formula

EMI = P × r × (1+r)^n ÷ [(1+r)^n − 1]

P = loan amount, r = annual rate ÷ 12 (as a decimal), n = tenure in months.

Monthly rate

r = annual rate ÷ 12

Convert 12% p.a. to 0.01 per month. Convert years to months for n.

Interest part of an instalment

Interest = opening balance × r

Use the balance at the start of that month.

Principal part of an instalment

Principal repaid = EMI − interest

Closing balance = opening balance − principal repaid.

Total interest paid

Total interest = (EMI × n) − P

Assumes no prepayment and no change in rate.

Floating rate structure

Lending rate = benchmark + spread

Benchmark can be the repo rate (RLLR) or the bank's MCLR.

EMI-to-income (FOIR / debt service ratio)

Total monthly EMIs ÷ Gross monthly income × 100

Include all existing EMIs plus the proposed one. Check whether the question says gross or net income and use what it states.

Debt-to-asset ratio

Total debt ÷ Total assets × 100

Lower is safer. It measures solvency.

Liquidity ratio

Liquid assets ÷ Monthly expenses

Answer is in months. Compare with the 3 to 6 month guide.

Loan-to-value (LTV) ratio

Loan amount ÷ Market value of asset × 100

Own contribution (margin) = 100% − LTV.

Maximum affordable new EMI

(Permitted ratio × Monthly income) − Existing EMIs

Use the ratio limit given in the question.

Maximum loan from EMI

Loan = EMI × [1 − (1 + r)^−n] ÷ r

r = monthly rate, n = number of months. This is the present value of the EMI annuity.

Common score range

Credit score range = 300 to 900

Higher is better. Scores near 750 and above are generally treated as good by lenders, but each lender sets its own cut-off.

Credit utilisation ratio

Credit utilisation = Credit card outstanding ÷ Total credit limit × 100

Lower utilisation is better for the score. A commonly quoted guide is to keep it well below about 30%, but that is a rule of thumb, not a fixed rule.

Report versus score

Credit report = detailed history; Credit score = numeric summary of the report

Do not mix the two in exam options.

Free report right

One free full credit report per year from each CIC

This is an RBI-mandated right for individuals. Extra reports may be charged.

Credit Information Companies

TransUnion CIBIL, Equifax, Experian, CRIF High Mark

Four CICs licensed by the RBI under the CIC (Regulation) Act, 2005.

Interest saved by prepayment

Interest saved = Interest that would have been paid on the prepaid amount over the remaining period

Approximate for exams: prepaid amount × loan rate × years remaining. Use the exact EMI schedule only if data is given.

Prepay vs invest rule

Prepay if loan rate > after-tax expected return on investment (adjusted for risk)

Prepayment return is certain. A risky investment must offer a clearly higher expected return to justify not prepaying.

After-tax loan cost

Effective loan cost = Loan rate × (1 − tax rate), only where the interest is deductible

Deduction limits apply, so apply this only to the portion that actually gets the deduction.

Balance transfer break-even

Break-even (months) = Total transfer costs ÷ Monthly saving

Transfer only if the break-even is well within the remaining tenure.

Avalanche order

Rank debts by interest rate, highest first

Minimises total interest. Snowball ranks by outstanding balance, smallest first.

Tenure vs EMI option

Part-payment with same EMI → shorter tenure → lower total interest

Part-payment with lower EMI keeps tenure → better cash flow, less interest saved.

Section 24(b): self-occupied home loan interest

Deduction = lower of (interest paid, ₹2,00,000) per year

Applies if construction or purchase is completed within 5 years from the end of the financial year of the loan. Otherwise the limit is ₹30,000.

Section 24(b): let-out property

Interest fully claimable; house property loss set-off against other income ≤ ₹2,00,000 per year

The cap applies to set-off of loss, not to the interest claim itself. Excess loss is carried forward.

Pre-construction interest

Claim = 1/5 of pre-construction interest each year, for 5 years from year of completion

For a self-occupied house, current-year interest plus the 1/5 instalment is together subject to the ₹2,00,000 limit (₹30,000 if completion is late). For a let-out house, the combined interest is claimable in full; only the set-off of the resulting loss against other income is capped at ₹2,00,000.

Section 80C: home loan principal

Principal + other 80C investments ≤ ₹1,50,000 per year

Stamp duty and registration charges count in the year paid. If the house is sold within 5 years of possession, the deductions claimed earlier are reversed.

Section 80E: education loan interest

Deduction = interest paid, no cap, for 8 years from start of repayment or until interest is cleared

Interest only. Principal is not deductible. Loan must be for higher education from a bank, financial institution or approved charitable institution.

RBI prepayment rule

Floating rate loan to an individual: prepayment or foreclosure charge = nil

Fixed rate loans may carry charges as per the agreement. Recent RBI directions extend the no-charge rule to all regulated lenders for individual floating rate loans and to some small business borrowers.

Release of property documents

Documents returned within 30 days of full repayment; delay compensation ₹5,000 per day

Applies to RBI-regulated lenders for loans closed on or after 1 December 2023. The lender must also inform the borrower of the arrangements for collecting the documents. It must pay the compensation if the delay is its own fault.

Quick revision

• Debt can help build assets or smooth cash flow, but it must fit the client's income and goals.
• Secured loans are backed by collateral; unsecured loans are not, and usually cost more.
• EMI is a fixed periodic payment covering interest and principal.
• Interest is charged on the outstanding principal, so early EMIs carry more interest.
• A longer tenure lowers the EMI but increases total interest paid.
• Floating rate loans change with the benchmark; fixed rate loans stay the same for the agreed period.
• Debt ratios compare loan obligations to income; a lower ratio means more comfort.
• Keep monthly and annual figures consistent when computing any ratio.
• A credit score summarises repayment behaviour and is built from credit bureau reports.
• Prepayment usually reduces interest cost most when done early in the loan.
• Restructuring changes repayment terms for a borrower in difficulty and may affect the credit record.
• Check the workbook for current tax deduction rules and limits on loan interest and principal.

Common mistakes

• Saying all debt is bad. Fix: Remember that debt can be a planning tool when the benefit exceeds the cost and it is affordable.
• Saying a loan taken to buy an asset immediately raises net worth. Fix: Assets and liabilities rise by the same amount, so net worth is unchanged at the start.
• Treating a loan against securities as unsecured because you still own the shares. Fix: The pledged securities are collateral, so the loan is secured. You just cannot freely sell them.
• Calling a credit card balance a secured loan. Fix: A standard credit card has no collateral. It is unsecured revolving credit.
• Using the annual rate and the number of years directly in the EMI formula. Fix: Always use r = annual rate ÷ 12 and n in months.
• Charging interest on the original principal every month. Fix: Charge interest on the opening balance of that month. The balance falls as principal is repaid.
• Leaving existing EMIs out of the ratio Fix: Add every current EMI (car, personal, card) to the proposed EMI before dividing.
• Mixing annual income with monthly EMI Fix: Convert both to monthly or both to annual first.
• Treating credit score and credit report as the same thing. Fix: Remember: report is the full history, score is the number computed from it.
• Saying SEBI regulates credit bureaus. Fix: CICs are licensed and regulated by the RBI under the CIC (Regulation) Act, 2005.

Exam tips

• Expect scenario questions: classify by purpose first, then check cost and affordability.
• Watch for absolute words such as always and never in options on good or bad debt. They are usually wrong.
• Remember that net worth is unchanged when an asset is bought entirely on loan.
• In case-based questions, link debt to cash flow and emergency fund, not just to the interest rate.
• Expect direct classification MCQs: pick which product is secured or unsecured. Settle collateral first.
• Watch for absolute words like always and never. Rules on rates and tenure are general patterns.
• For credit cards, know the revolving nature, the interest-free condition and extra charges for cash withdrawal and late payment.
• For education loans, remember the moratorium idea. For gold and securities loans, remember the pledge and the cushion between loan and asset value.