Part 1: Taking a Loan (Being in Debt)

Whatever I am going to post today was supposed to be done by someone else but.... :)

If you have followed my past postings, Debt Management is a topic which I had posted in bits & pieces. Today, I will try to piece all the bits together within the next hour or so. I will discuss on how different type of loans affect two different families in their 20s & 30s.

Before I further evaluate the families' loan profile, let me go into some basics on Debt instruments. Debts or Loans can be categorized in two forms - Secured or Unsecured.

Unsecured loans are short term loan given to any individual without the need to pledging any form of collateral (e.g. Renovation loan, education loan, personal loan from banks). Secured loans are loans which are secured with an underlying asset (e.g. a property, bonds cert., stocks etc).

Now, let me take a peek at the profile on these two families and see how i can help them:

Family A:
Husband - 27 yrs, employed
Wife - 25 yrs, employed
Gross Combine Income - $5,000
Monthly Expenses - 25% of income
Mortgage Loan - $300,000 for 30 years from HDB
Wedding Dinner in November 07 - Budgeted at $20,000
Wife has a life policy of Sum Assured $100,000, Husband has none.
Plans to buy a family car in 2 years
Currently do not have any investments, but keen on unit trust or equity investments & no other savings

Family B:
Husband - 37 yrs, self-employed recently
Wife - 38 yrs, employed
2 kids aged 1yrs & 3yrs
Have a maid & a Nanny
Gross Combine Income - $8,000
Monthly Expenses - 30% of income
Mortgage Loan - 20 years to go with monthly repayment at $1200 from CPF for their HDB Executive flat
Saving more than 50% household income - invested in unit trust funds
Husband pays about $1800 for endowment plan, ILP and MRTA, but no life insurance
Wife & kids have few life policies but not sure if adequate
Plans to buy a family car (MPV) soon

With the limited information provided, I would need to make the following bold assumptions:

1. Both families do not have any short term debt liabilities like outstanding personal loan, renovation loan, credit card or personal line of credit.
2. All of them have good credit rating in their Credit Bureau records

My Findings & Recommendations: Family A

On their mortgage loan:
At the moment, the couple is enjoying subsidized rates form HDB at 2.6%p.a. (CPFOA rates + 0.1%). Compared to the interest rates offered by banks in the market, this couple is considered to be enjoying great discounts on their mortgage loans. Hence, unless the bank’s mortgage interest rates fall below 2%p.a., they should not be looking at refinancing.

Wedding Plans:
Wedding bills can be quite hefty. Paying cash would be a good idea, although not the best thing to do. With a combined income of $5,000, the couples could invest some time to pick up a few credit card facilities before their wedding in November 07.

These credit cards will come handy to split the $20,000 wedding bill into affordable installments (possibly 0% interest) should one decide to pay off slowly. Should they wish to pay off it as a lump sum, the couple has up to a maximum of 45 days grace to do so with no additional charges. At the same time, the couple can earn points from the credit cards in exchange for house warming gifts for their new home at almost no cost.

Buying a Car:
Just like anyone out there, I am your typical Alpha man who is crazy about owning my very own sports car. I went to a car show in late 2004 empty-handed, out with a Subaru Impreza 1.6(A) and a mountain of debts. Haha, now half my salary goes to paying out the loan, petrol, parking and maintenance costs. This is the trauma for switching my sales job or a management role in the company. Sigh.

However, I would encourage those who have intention to get a car to do so. Why? We have to rationalize that the convenience it brings is second to none (of course, there are problem in getting parking space sometimes). Especially if the couple has the intention to start a family soon, it may not be a bad choice to own an economical vehicle.

As I would not be able to foretell the future pricing of cars & the respective interest rates, I can only advise that one should not have more than one-third of their salary going into a personal transportation tool; taking Taxi is definitely cheaper!

My Findings & Recommendations: Family B

On their mortgage loan:
At the moment, this couple is also enjoying subsidized rates form HDB at 2.6%p.a. (CPFOA rates + 0.1%). Hence, unless the bank’s mortgage interest rates fall below 2%p.a., they should not be looking at refinancing. However, they may consider taking up a bank loan if they need to use the unencumbered portion (paid up principal of the loan) of the property once their property privatized.

Other secured loans:
Getting a standby line of credit using the UT investments as collateral may not be a bad idea. Especially when Husband has just become self-employed recently, getting unsecured credit fro business is an uphill task. In addition, insurance policies with substantial cash value can also be pledged as collateral for getting required financing without the need to surrender such policies.

Buying a Car:
I would encourage this couple to get a car as cost is technically shared by the number of headcounts in the family. However, I still do not advocate spending more than one-third of their salary going into a personal transportation tool.

Run thru a few distributors which offer the same model (parallel importers might be able to provide better pricing but with limited warranty). If second-hand or repossessed cars are options, going for them might not be a bad deal. Just thought you might want to know, I bought my car in Dec 04 for $73,500, my loan outstanding is still over $70,000; a new car of the same model cost $55,800. Sigh….. Heartache….