As we have learned in the previous article, there are both good debts and bad debts. It all depends on several factors and the context. In this article, we will explore some of those factors and how we can avoid taking on bad debts and learn how to take on good ones.
1) Make sure the asset we buy is a good asset
Yes, this is quite obvious, isn’t it? Remember the example of buying a depreciating old property? Here’s another example, imagine taking on a 100k loan to buy a car. Nowadays, COE alone can reach up to $100k. If you add in the costs of the car itself, a “non-branded” car can easily cost another $60,000. The total costs of buying a new car would be $160,000! And most cars are actually depreciating items. Of course, depending on the needs, sometimes owning a car is essential. Perhaps in those circumstances, consider buying a second-hand “non-branded” car.
A good asset is income generating and the ROI should be greater than the existing interest rate. That way, we are still making money with borrowed money. An example of a good asset can be a good property that generates good rental and has decent capital appreciation.
2) Low loan interest is ideal
Ideally, when we take on a loan, we would want the interest rate to be as low as possible. That way, we would need to pay less interest. But what should we do if the interest rate is high? We cannot control the macro economics. In current times, interest rate has been rising quickly. Some of us were lucky and were able to sign on a fixed interest rate home loan when the rate was lower. However, not all of us are so lucky. In that case, when we decide to take on a loan, consider if the item that we are going to buy is a “need” or a “want” and whether you need it now. Also consider if that item is a good asset.
3) Make sure the loan tenure is as long as possible
The common thinking is to take on a shorter loan tenure and pay off the loan as soon as possible to save on interests. However, we fail to consider inflation. Inflation takes time to work its magic. Imagine the HDB used to be $100k 30yrs ago. Now the same flat is easily $400k. Inflation increases the cost of item, however, it also reduces the value of the loan. A long loan tenure allows more time for inflation to do its job – in our favour.
4) Make sure to invest the money we “freed” up on other good assets
In addition, we can use less money on the HDB and diversify our money onto another good asset that can potentially give us a good ROI in the long run. Do not let most of your money just sit in the bank doing nothing! That way, over time, inflation will erode its value.
In conclusion, now that we are aware that debts are not necessarily all bad, we can avoid taking on bad debts and take on good ones! Especially in a high inflation and high interest rate environment, we need to be more aware of these factors and be wiser when we need to take on debts. With the right knowledge and knowing what to do, we can be less worried of high inflation and high interest rate environment. Remember, tough situations do not last and they will help us emerge wiser!