What Are Some Misconceptions About Debt MLA

Debt is usually a word that is frowned upon. That said, not all debt is bad. Things are a bit more complicated in reality. This explains why you will see a high net worth individual who can afford to buy a house in cash taking a mortgage. Here are some tips on how to distinguish between good and bad debt, and a few other common misconceptions about debt.

1. All Debt Is Bad

A debt that you can use as leverage is good debt. For example, you might take a mortgage repayable in 25 years and have to pay S$7,000 a month. This might seem like a heavy financial burden to most Singaporeans, but a savvy investor will consider that the property is likely to generate around S$8,000 in rent. This leaves you with S$1,000. After the 25 years, the building will most likely have significantly appreciated in value and you can always sell it for a tidy profit. So, a simple way of determining whether debt is good or bad is comparing the debt repayment and the returns.

Education loans are also good debts. Tertiary education is costly in Singapore and if you decide to be debt free, you will not be able to afford it. This will mean missing out on career opportunities that require tertiary education (and which pay a lot more). In most cases, five years’ worth of income is enough to pay off a university loan. In most cases, courses that are expensive at the university level have better payoff, examples being law and engineering degrees.

Any business or investment loan you take to start or expand a business is good debt. Once the business is up and running, it will generate revenue and profit that will cater for the debt.

However, it is always important to remember that life is uncertain and the above outcomes are not guaranteed. As an example, you can get an education loan and end up in a business that is unrelated to your college degree. There are always risks in investments.

On the other hand, bad debts are debts that you are unlikely to recover/that do not generate returns. Some bad debts such as debt taken in medical emergencies are unavoidable, but some like debt taken to buy luxury items and to go on holiday can be avoided by simply saving for what you want.

Credit card debt, payday loans and other debts that have interest rates in excess of 20% are bad debt. Car loans are also considered to be bad debts because cars start losing value the moment they leave the lot. You could repay bad debt using loans that have low interest rates such as lines of credit and home equity loans.

2. You Cannot Get A Loan If You Have A Bad Credit History

There is a common misconception that people with bad history cannot access loans from reputable lenders, leading most of them to seek loans from loan sharks.

Different lenders have different eligibility criteria. Although there is a certain score below which lenders will not give loans, lenders generally use the credit score as a general guide on a person’s ability to repay the loan and consider it alongside other factors like how their business or employer is doing and even the circumstances that led to the poor credit score.

You can take active measures to increase your credit score consolidating your debt to reduce the risk of defaulting, by being disciplined in your spending, and by keeping balances low on credit cards.

3. Lenders Have Roughly The Same Interest Rates

Although most Singaporeans know different lenders have different interest rates, they make the wrong assumption that these rates are only a few percentage points off each other. Large lenders who have financial clout usually have lower interest rates compared to smaller lenders, but this is not written in stone.

Lenders consider your personal situation when determining interest rates. The insurance component of the loan also varies greatly between different lenders.

It is not uncommon for leading lenders to go on loan wars that greatly distort the interest rate scene. A good example of this is the home loan war that started in February 2017 between UOB and DSB; affecting their FHR (fixed-deposit home-loan rate) packages.

4. Increasing Your Loan Term Means More Interest

Although increasing the term of a loan generally attracts a higher interest rate, you could negotiate with your lender for a longer-term loan that has a lower interest rate, which means less interest. Most lenders are flexible when it comes to loan terms, especially when there is a risk that you will default on higher repayments.

If there are no pre-payment penalties, you could then take advantage of the longer-term loan and pay it off quicker to reduce the period you have to be indebted if your financial situations improve. This arrangement gives you great flexibility.