Tuesday 7th Feb 2012 11:41 PM
5 Steps To Better Debt Management
A couple of months back, we talked about different types of debt and how to make better use of our credit. It may be useful at this time to consolidate all these information together into a coherent plan on how to manage our debt. In the interest of simplicity, we created 5 steps which we consider vital phases to help consumers better manage our debts. We'll talk in detail about each of the steps below:
Step 1. Consolidate Your Debt Information
Step 2. Find Out How Much You Can Pay Every Month
Step 3: Determine The Priority Of Each Loan
Step 4: Find Alternatives To Your Highest Interest Rates
Step 5: Update Your Debt Status
1. Consolidate Your Debt Information
Consider a typical middle-income Singaporean, married and working for a couple of years, with a car and a house. This typical Singaporean will likely have a number of debts that he or she is currently servicing. A list of the most common debts for this profile is shown below.
|
Secured Loans Home Mortgage Automobile Loan |
Unsecured Loans Credit card debt Installment loans Education loan |
|
|
|
If you do not know how much debt you are in, you will not be able to gauge how much you should pay to get out. The first step towards debt management is to find and list down these debts. Include any loans you take out for household or personal expenses, even if you always pay them back when you get your paycheck. Your list must at least include the following:
- Total debt amount
- effective interest rate
- start date of payment
- estimated duration of repayment
- current monthly repayment sum
- sum you already paid so far for the loan
FAQ: How Much Is Too Much?
If you are regularly taking out loans to meet your monthly expenditure, and do not have enough to pay down your other loans, you are overspending. A lot of people do this thinking “I’ll pay it off next month”, without realizing that monthly expenses typically increase, not decrease, every month. There’ll always be some new item or one-time expense you have to pay off. The best thing to do in this case is to separate your budgeted living expenses from your normal bank account to another account, so that you get a better idea of how much you have to spend every day.
2. Find Out How Much You Can Pay Every Month
Start with your take-home salary (after deducting CPF & taxes), and list down the monthly expenses you incur. Annual expenses should be included as well by breaking them down into monthly expenses. Deduct your basic living and family expenses, and any regular monthly savings from your salary. What’s left should be the money you normally spend on luxury items, gifts, nice restaurants, or put into investments.
This sum of money shows the maximum repayment sum you can afford with your current salary. If 100% of it goes towards paying off your debt, it either means you are too deeply indebted or you are overzealous in repaying your loans.
As a general rule, it may make sense to pay off your debt as soon as possible, but working without a bit of comfort now and then guarantees burnout in the long run for all but the most disciplined of us.
A good rule of thumb is to budget around 60 to 70% of this sum for any loan repayments and treat the rest as disposable income. This percentage differs depending on how deeply indebted you are, so use your judgment.
FAQ: What if I want to invest the money instead?
That depends. If you wish to invest the money, you should first ask yourself if your returns are likely to cover at least the interest rates of the loan. For instance, if you wish to invest $4000 and you have an outstanding loan of $20,000 with 17.8% p.a. interest to pay off, which is the usual rate for an unsecured personal loan, you must make at least S$3560 p.a. to break even. That’s nearly a 90% return rate, and you only cover the interest for the year. Conversely, if you use the $4000 to pay off the loan, you cover the interest rate and some of the principal. This is a bit over-simplistic but you get the idea.
3. Determine the priority of each loan
Assuming that we have enough money to repay our monthly loan installments, we should first prioritize loans according to whether they are secured. Secured loans typically come with lower interest rates and better repayment terms than unsecured ones, in return for you incurring higher risk. As long as there is no risk of defaulting on your secured loans, always prioritize repayments for unsecured loans.
When looking at unsecured loans, you should rank them by the interest rates they charge, with the one with the highest interest on top. If you cannot find any alternatives to these interest rates charged, use the bulk of your monthly repayment budget to pay off the highest priority loan, and pay minimum sums for the rest.
4. Find alternatives to your highest interest rates
Now that you know what loans you have and how urgent each one of them is to repay, you should get creative and see if you can find ways to reduce the interest rates of these loans. Below are several methods you can try:
i. Exchange an unsecured loan for a secured loan
As mentioned, secured loans give you far better repayment terms and interest rates in general, as most of the risk is passed on to you when you pledge your possession to secure the loan. If you default, they force-sell the possession and get their money back. If you are confident of paying back your loan, however, it is a great way to save some money.
In Singapore, there are several possessions you can use to secure your loan:
- Insurance Life Policy
- Property (Mortgage)
- Investments (Equities / Bonds / Funds)
- Car
- Business Assets & Equipment (Business Loan)
- Accounts Receivable (Business Loan)
Note that property and car loans can only be taken on again once you finish your original payments for your house and car.
Balance transfers can be used to temporarily stall the crippling 24% interest rate charged on credit card balances. Note that balance transfers typically require you to pay a one-time transfer fee of 1 to 3% of your outstanding credit card balance to the bank, and they expire within a fixed number of months, after which the normal crippling interest rate applies, so they are not really “interest-free”. Still, they are good temporary solutions that help ease your monthly loan burdens.
Debt consolidation refers to consolidating all debts under a single loan with a single interest rate to monitor. This simplifies the monitoring process for your debts and may give you more flexible repayment terms depending on the nature of your loans. One example will be to do balance transfers of outstanding balances from your various credit cards to a single bank, and taking on an installment loan or secured loan with fixed interest rates to pay off the other higher-priority loans.
Note that this does NOT entail going to a private money-lender and asking for a debt consolidation plan. For some reason, the term “debt consolidation” in Singapore seems to imply services to help heavily indebted individuals who require renegotiation of their debts with their debtors or risk bankruptcy. This practice is neither desired nor practical for consumers who can afford to pay off their loans.
5. Update your debt status
Remember the list of information you made about your debts in step 1? After you’ve done all you can to reduce the interest rates applicable for the loans, it’s time to determine the repayment sum to allocate to each loan.
If you follow our advice and pay off the highest priority loan one by one, you should eventually see a marked decrease in the number of loans you have with different institutions. Not only does this mean that you can repay your remaining loans faster, you also have less debtors and banks to deal with. Remember to update your debt status regularly so you know just how much you have to repay
So after you read this article on debt management, do you have any questions of your own regarding debts that you wish answered?
Post that and more as you check out our question of this week
Have A Good Weekend!
Yours Sincerely,
Tony Koh
Webmaster, Qotion.com