Debt Solutions

There is good debt and there is bad debt, how do you tell the two apart?  Good debt does good things for your financial standing, helps you build assets and there is potential for the value to appreciate like property, business, stocks and unit trusts.  On the other hand, bad debt is defined as consumption debt like hire purchase for cars and credit card debt. 

The nature of the debt doesn't only depend on what the loan is for but also on whether you can make your money work harder for you.  For example, if you can get a higher return compared to what you're paying for interest, it may pay to borrow to invest.  Leveraging on a loan can help improve your financial standing by reducing the interest charges you pay overall and help you reduce your debt faster.  Another example of a good debt is an educational loan or loan given to employees to take up share options, when the market price is significantly higher than the exercise price of the shares. 

Bad debt is not only borrowing to gamble, but also a loan with unfavorable terms and conditions like an overdraft facility of $95,000 against a fixed deposit of $100,000 as collateral or credit facilities with excessively high interest rates. 

You need to look at the risk versus the return and the period required before a profit can be made.  It may be a good investment but the person may have no individual ability to sit it out and service the debt until the investment gains can be realized.  When taking out a loan, consumers should factor in all the costs involved including legal fees, stamp duty and any commitment fees for unutilized portions of a line of credit.  Not only that, make sure you compare 'apples with apples'; a 4.6% interest rate per annum on a hire purchase, no-rest term loan is not cheaper than a daily-rest 6.2% per annum interest rate on a housing loan. 

The ubiquitous credit card is often the most hassle free way to obtain a line of credit, but it's also one of the most expensive in terms of interest rates.  What's the alternative then?  Is it an overdraft? 

If you have a standby line of credit, you can draw on the overdraft instead of on a credit card, as the benefit is savings in interest expense.  If you're planning to use an overdraft to help pay off another debt, check out the terms and conditions applied.  Overdrafts are normally need collaterals like fixed deposits, shares, unit trusts and property.  Drawing fully on an overdraft secured with cash to pay a credit card debt doesn't make sense. 

If you have to pledge a fixed deposit to get an overdraft, you might as well take the cash to pay off the debts.  After all, a fixed deposit may earn you 3% per annum while the loan may cost you 8%. 

There's an argument for obtaining a secured overdraft; you may not want to liquidate your assets, but you want to have a line of credit on standby.  The fixed deposit may be maturing in 6 months and people may not want to uplift it and lose out on the interest, thus they obtain an overdraft for that amount.  When the fixed deposit matures, they pay off the loan. 

Consumers should differentiate between their short, medium and long-term borrowings.  If you have $50,000 in short term debt like credit cards, you can opt to convert your borrowings into a term loan, which comes with a lower interest rate, over a period of 3 to 5 years.  If you hold several credit cards, you may want also be able to obtain one umbrella term loan to pay them off, thereby consolidating your debt. 

While taking a cheaper loan to repay debts may work out in the mathematical sense, be careful that you're not just creating more bad debts.  It's necessary to practice financial discipline and maintain control of this facility.