Most people believe that debt is bad, and try to minimise liabilities of all kinds to ensure the mounting debt doesn’t catch them off-guard. Of course, accumulating a large amount of credit card debt and personal loans could potentially turn one’s life upside down. However, it is important to note that not all kinds of debt is necessarily bad. In fact, some loans can actually be useful, if not essential, in helping people increase their welfare. Here, we discuss a few main examples of bad and good debt to help our readers make smarter decisions with their finances.
Credit card debt: bad and avoidable
With consumerism at its peak, credit card debt in Singapore is growing extremely quickly, hitting a high of S$10,801 in 2016. As the fastest form of consumer debt in the country, credit card debt is perhaps one of the worst kinds of debt to get stuck with. This is especially true given the high interest rate of at least 25% that credit cards charge on your balance. If you are not careful to quickly pay it off, your balance can easily double or more in a matter of months.
With all this being said, credit card debt is actually the most avoidable. What’s most required in reducing this liability is a little restraint on your part. You can start by reducing your spending and using the extra cash to pay off as much balance as possible. You can also take out a debt consolidation plan to help alleviate the burden of high credit card interest rate while you pay down your balance.
Car loans: bad but unavoidable
Since cars are a depreciating asset, they aren’t, and shouldn’t, be considered an investment. Hence, borrowing money to purchase a car isn’t exactly a great financial decision, especially in a country like Singapore where public transportation is so robust. However, for those who do want a car, taking out a car loan is essentially unavoidable given the sky-high car prices in the country. Just because it’s unavoidable, however, it doesn’t mean there are ways you can be smarter about getting a car loan to get some extra savings.
First, it’s generally a good idea to comparison-shop for a car loan online instead of accepting the offer from your car dealer. Dealers operate in a very competitive industry, so they’ve been known to increase their profit margins through these “value-add” services like loans, insurance and servicing. Apart from this, minimising the tenure of your loan as much as possible can keep your interest costs low. Finally, we’ve also found that both using ride-hailing apps and renting a car from Grab/Uber to drive for them part-time can actually be great alternatives options as they are even cheaper than owning a car.
Home loans: good and necessary
A home loan is a prime example of debt that can actually be good for people. Because the lender takes the borrower’s home as a collateral, these loans typically carry a very low interest rate. Not only that, housing loans actually have the potential of increasing your wealth over time by serving as a source of leverage.
Let’s consider a simple example. Suppose you purchase a house for S$500,000, made a 20% down payment of S$100,000, and borrowed S$400,000 to cover the remaining amount. If you assume that your house’s value appreciated to S$600,000, your investment of S$100,000 would’ve have increased to roughly S$200,000. This is a classic example of the beauty of using leverage in investments. Had you paid the entire S$500,000 of purchase price with your money (assuming you could afford it), your investment would have appreciated only by 20% in this example. Instead, a housing loan of S$400,000 can serve as a very cheap source of leverage that boosts this return to 100% by reducing your initial capital commitment required to purchase a home. Morgan Stanley expects property price in Singapore to double by 2030, a change from the protracted downtrend present since 2014. If this is true, home loans can really be of value to savvy property investors.
Education loans: good
Student loans provide you with the opportunity to pursue a post-secondary education without actually bearing the entire financial burden before you graduate and find a job. This particular type of loan allows you to increase your value overtime and helps secure your financial future. According to the data we collected from the Ministry of Manpower indicates, workers with post-secondary education earn almost double what people with lower degrees earn: the average monthly wage was only S$2,259 for non-degreed workers vs S$4,642 for workers with post-secondary degrees. With a degree in hand, your chances of finding a stable and well-paying job dramatically improve, and this is an solid return on investment compared to the cost of a student loan that generally ranges around 5% per year.
Business loans: neutral
Being an entrepreneur is great – you don’t need to answer to anyone and life can become much more fulfilling than a corporate job. Getting a small business loan may sometimes be a good, if not necessary, way for to grow your business or even to keep your business afloat.
However, there are many other alternative sources of funding that you need to explore before committing to a business loan. For one, there are many crowdfunding platforms like KickStarter, GoGetFunding and FundedHere that can provide you with various kinds of capital (pre-purchase, donations, equity investments) quite quickly. These come with their own set of downsides like being restrictive in how you spend the money, but they can often be much cheaper source of funding than a business loan. At the end of the day, the most important thing is that you shop around and consider a variety of different options so that you get the best kind of financing with the terms, structure and costs that work for you so that you can continue to grow your business.
The article Loans: Exploring the Good vs the Ugly originally appeared on ValuePenguin.
More From ValuePenguin:
- Should You Get a Personal Loan for Your Business?
- Best Personal Loans in Singapore 2017
- Best Home Loans 2017