To many Singaporeans, carrying debt is bad. To them, we should try our best to limit the amount of loans and borrowings we have as debt is view as a hazard looming over our shoulders waiting to cripple us one day when we’re not attentive.
These Singaporeans are absolutely right. Having a lot of debt creates the potential to wreak havoc if we are NOT PRUDENT. When we’re not attentive, credit card debt and personal loans can spiral out of control. In Singapore, where households are highly leveraged and many are plagued with credit card debt, there could be a case for trying to avoid debt.
However, few people in Singapore are able to save enough to pay in full for the most important purchases in our lives – our homes and our education – and the expensive COEs (Certificate Of Entitlements) certainly do not help either.
Let’s first understand how debt works.
How Debt Works
The premise for understanding how to manage debt is simple. Think of it as renting a car, you need to pay for that privilege. Would you rent a car if you cannot pay for it? The same concept applies to debt – which is basically the bank’s money. When you “rent” this money from the bank, you need to pay for it.
How much you end up paying is usually determined by how much you make the bank worry. If they completely trust that you will be able to repay the loan, you only need to pay a small price for renting their money. However, if they are really worried over your ability to repay the loan, you will have to pay a larger price to convince them that it’s worth their while to “rent” their money to you.
Typically, banks are less worried if you are able to guarantee repayment of the loan with something valuable, such as your house or investments, or have a good credit score.
Good Debt VS Bad Debt
Good debt typically allows the borrower to potentially multiply wealth while bad debt destroys the borrowers’ wealth. This is one of the reasons people say “the rich get richer, while the poor get poorer”. The rich are able to use debt prudently to build up their wealth while other people stay away or mismanage debt.
Taking up a loan to buy your home is an example of taking on good debt. Very few people are able to pay off properties in full and home loans are typically less expensive as you have to put up the house as collateral. This means, the banks will be much less worried of your ability to repay the loan. HDB (Housing and Development Board) loans currently stand at 2.6% while bank loans are slightly less, hovering at close to 1.9%.
You can even take out additional home loans against your property at attractive rates to pay off other high interest loans or invest at a higher rate of return.
If you are investing in a property, you can also take out housing loans to pay for your property while you collect income from renting your property out. Furthermore, interest rates and additional expenses paid on the home is tax deductible.
However, you should be wary of falling property prices which will trigger banks to call for owners to top up loans. Rising interest rates is also another area of concern for property investors. In the past few year, property prices have also stagnated due to various government cooling measures for residential properties in Singapore.
Education is also an important and good debt to take on. A study by the Economist Intelligence Unit (EIU) forecasts that the unaffordability of education in Singapore is set to soar to 70.2% of Singaporean’s yearly income compared to 53.1% in 2015.
This does not mean that Singaporeans should avoid educating themselves. A good education from a local or foreign university ensures increases your lifetime employability and improves your ability to earn a good future wage.
With loans hovering close to 4.5% to 5.9%, education loans tend to be slightly more expensive compared to home loans but are nevertheless equally important. A high quality education would enable for better income post-education, which would more than offset the cost of getting the education.
One additional risk is that foreign degrees tend to be several folds more expensive compared to local degree. Hence, the cost outlay may not be justifiable if you are not able to enough to quickly repay the loan amount after graduation.
Entrepreneurship is fantastic – it lets you be your own boss and allow you explore a more meaningful and fulfilling life. A business loan allows you to expand your business much faster or get out of a short-term cash flow problems.
This also allows you a great chance to leverage on your hardwork and intelligence to provide a big payoff by becoming really successful. The Singapore government has also been more involved in this area backing SME Micro Loans from as little as $100,000 to Bridging Loans to the Marine and Offshore Sector companies of up to $5 million.
The downside is that 9 out of 10 businesses usually fail, and prudent management of cashflow and balance sheet should be the rule of thumb.
Credit Card Debt:
With interest rates going through the roof, usually upwards of 24%, credit card debt is one of the worst forms of debt to get mired in.
Consumerism is part and parcel of bustling Singapore where everyone has the newest phones, most fashionable clothes and dine at the trendiest bistro. The most amazing thing is that all it takes to avoid being in credit card debt is simply some restraint on your part. It’s no rocket science.
The irony is that credit cards can be a powerful ally. It offers you interest-free loans for up to a full month, the convenience of being able to avoid the hassle of carrying (and potentially losing) large amount of cash and the ability to earn rewards and/or cashbacks.
We’ll stop playing it up here, as we fear it may get even more people to jump on the credit card bandwagon.
Your car loan is servicing a depreciating asset. Singapore is a tiny country by any comparison on the global stage, and with the public transport already in place, and more to come, there is an extremely good case for people to never require owning cars.
Besides being exorbitantly expensive, you’re also required to purchase a COE to drive it for a mere 10 years. On top of that, you have to pay for fuel, parking, insurance and anything that may go wrong with the car.
Some people may, however, require cars to conduct their business or to ferry young children or elderly parents. If they can afford it, and if the ends justify the means, there’s nothing to stop them from buying cars.
The “Iffy” Debt:
One type that potentially sits in this grey area is instalment plans. Some instalment plans make sense if they’re coupled with your credit card and you pay 0% interests. As good as it sounds, there are drawbacks. You will be more inclined to making large ticket purchases with little regard on your future ability to repay these loans. It also encourages the habit of swiping your plastic for every purchase you make which may get out of hand.
The other grey area debt is instalment loans that allow you to purchase items by slapping a three-year repayment scheme on you. While the amount to fork out each month may seem tiny, bear in mind the additional costs you are incurring in interests.
Both of these types of debt have very high interest and fees for non-payment or late payment.
A Disciplined Approach
Debt is both a boon and a bane. It has the ability to put a roof over our head and the ability to destroy our wealth today. We need to understand how to manage debt in order to fully benefit from the use of debt.
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