Debt, in essence, is all about borrowing money from a third party, and having the means to pay it back. Debt is not always bad news; it really depends on the kind of debt you currently have and your ability to pay it back. Let’s take a closer look at ‘good debt vs bad debt’.
Therefore, let’s start off with a self-assessment on debt. Referring to Table 1, kindly answer the statements with a “yes” or “no”. The more “no” in your replies, the higher your stress level in debt management.
| 1 | My monthly loan servicing ratio over my monthly income is about 38% or below. | |
| 2 | I am only investing my free money and never borrow to invest. | |
| 3 | I have consistently (monthly) and/or fully paid my credit card debts. | |
| 4 | I keep a track of my total debts annually and it is decreasing over the years. | |
| 5 | I know the difference between good and bad debt, and only utilise the good debt to acquire appreciating assets like property. | |
| 6 | I pay all my household bills on time. | |
| 7 | I am current on all my debt payments. | |
| 8 | I know who to look for help if any of my family members r I are in deep debt. | |
| 9 | I know the risks of becoming a guarantor, co-loan owner and supplementary credit card owner. | |
| 10 | I know the interest rate of each loan that I borrowed, and how the interest is charged on the loan amount. | |
| 11 | I know how to restructure my debt wisely if needed, and clear the loan with the highest interest rate first. |
Good Devt VS Bad Debt?
Did you know that debts can be categorised as “good” or “bad”? Good debts refer to the ones with low-interest rates (below 8%), and your borrowing is used to purchase appreciating assets such as residential or commercial properties, or investing in a business.
A study on Malaysian property valuation between 1991 and 2014 showed that the compound annual growth rate (CAGR) for overall property in Malaysia is around 5.97%。No doubt that property is an appreciating asset, still location is key for greater return.
Bad debt, on the other hand, is akin to borrowing money to buy a car, which is a depreciating asset, although the loan interest rate is considerably not high (around 4-6%). Every year, the car value will drop at an average of 10%.
From Table 2, it is crystal clear that we shouldn’t borrow if the interest rate is more than 8%.
| Debt Type | Average Interest Rate (Annual) |
| Illegal Shark Loan | 60% |
| Credit Card | 15-18% |
| Personal Loan | 10-12% (Promotional 8.88%-9.99%) |
| Education Loan | 8-10% |
| House Loan | 4.5-6.5% |
| Car Loan | 4-6% |
| PTPTN | 1% (3% is the old rate) |
Words Of Advice
Healthy Debt Ratio – A key indicator on whether you have a healthy debt ratio is the Monthly Debt Servicing Over Monthly Income Ratio. It simply totals up your monthly debt repayment amount over your monthly income.
This ratio should always be kept below 40% at all times, though a temporary spike is still acceptable. For those far below 40%, you have more room to gear on appreciating assets resulting in easier loan approvals.
Never Borrow to Invest – The first rule of financial planning is not borrowing to invest, even in share margin investment, where the interest rate is low at about 4%.
We should only invest free money. Don’t borrow money even from family members, relatives or friends to invest. Otherwise, it could cost you both money and relationship.
Get the Longest Loan Period (if possible) – Forget affordability, will you apply for a 25-year loan (instalment: RM2,400) or 35-year loan (instalment: RM1,200) for a property purchase?
Choosing 35 is a wiser strategy to deal with loan and cash flow. Even if you opt to pay RM2,400 (instead of RM1,200) monthly and consistently, the loan will end in 25 years.
However, if you select the 25-year package, there is no way you can reduce your monthly repayment if you have cash flow problems in certain months.
In the event you don’t pay consistently, banks will increase the interest rate causing the repayment amount to rise, lesser free cash in hand, and a whole lot more stress!
If non-repayment continues for two months or more, you will be seen as failing to service your home loan, and worse, the bank might even auction your house. Therefore, why risk your financial position with a shorter period of loan which offers lesser flexibility?
The longer the tenure of your home loan, you would have more cash in hand to actively invest into an investment instrument that can give you an annual return of more than 6%. This is smart financial planning.
About the Author
This article is written by Yong Chu Eu. He is the Founder, Principal, MFPC Shariah RFP, CPD/CPE, HRDF Certified Corporate Trainer of Money & Life, Financial Book Author, Licensed Financial Planner, E2E Financial Literacy Principal Coach & Local Media Guest.
