Should You Pay Off Your Debt to be Debt Free?

[Dennis Ng]

I'm writing a Personal Finance column once a month for the magazine "Share Investment", here's an article I wrote:

http://www.sharesinv.com/articles/2012/ ... debt-free/

Perspective| 16 March 2012
Should You Pay Off Debt To Be Debt Free?
By Dennis Ng

Many books on Personal Finance advised you to pay off your debt as soon as possible, so as to be debt free. However, many people do not know that there is a difference between good debt and bad debt.

Any debt on consumption is bad, as the value of consumables such as electrical appliances goes down over time. Thus, if you were to purchase consumables by taking on instalment plans, you would end up losing money. For instance, a flat-screen TV set might cost $5,000 or more four years ago. If you were to pay using a four-year instalment plan, by the time you finished paying, a similar TV set might cost only $1,000 or 80% cheaper.

What Is A Good Debt?
So what is a good debt? This refers to debt that is possible to earn a higher return than the interest paid. One common form of good debt is housing loan. If you want to buy a flat but do not have enough cash on hands or monies in the Central Provident Fund (CPF) to pay in full, you can get a housing loan.

Thirty years ago, a five-room flat cost approximately $100,000. If you withheld from buying because you were unable to pay in full, then 30 years on, you might realised that the same flat is now valued at over $400,000 – making it even more difficult to buy. Conversely, if you had paid a down-payment of $20,000 and borrowed 80 percent by a 30-year housing loan, even after assuming an interest rate of 5 percent, the total interest payable would only work out to be about $74,604 or a total sum of $174,604. Compared to the current market value of over $400,000, you will actually make a gain if you had taken on the loan.

High Interest Rate On Housing Loan?
Many people have the misconception that the interest rate on housing loan is high. If you were to borrow $300,000 and repay over a 25-year period, assuming an interest rate of 4 percent, the total interest payable is about $175,053. The monthly instalment would work out to be $1,583, of which $983 is interest payment while only $600 goes toward principal repayment. Thus, many people try to make lump sum repayment as they want to pay off their housing loans as soon as possible. However, they forget that interest on housing loan is calculated on a reducing balance method. Fifteen years on, the loan outstanding would be reduced to $158,224 – each month, interest payable would reduce to $531 while principal repayment would rise to $1,052.

On the other hand, if you were to invest, your money would grow like a snowball. By investing $300,000 for a 25-year period, assuming an annual return of 4 percent, your sum would grow to $799,751 or by 266.6 percent. Hence, comparing the two, the total interest payable on housing loan is $175,053 while total return on investing is $499,751! So, if you’re still thinking of trying to pay off your housing loan as soon as possible, you would be better off investing your savings than making lump sum repayment on the loan.

While the average guy tries to pay off his debt, I observe that the rich borrow to become richer. One recent example is Genting Singapore, which recently issued bonds with an annual coupon of 5.15 percent. Considering the current inflation rate of 5 percent, the coupon would leave real interest at only 0.15 percent. Moreover, if Genting Singapore were to invest and achieve a return of 10 percent, it would make an annual return of 4.85 percent.

If you want to get rich, you need to think and act like the rich – instead of trying to be debt free, borrow money to become richer.

Dennis Ng is an accountant by training and has 19 years of bank lending experience. He founded http://www.HousingLoanSG.com, a leading mortgage consultancy firm in Singapore, in 2003 and is often quoted by the media for comments on financial matters.

He is also the founder of http://www.MasterYourFinance.com, a financial education portal, and conducts seminars to educate people on ‘How to Reach Financial Freedom and Secrets to Investing into Stocks and Property’. He is also the author of the first chinese/english book on personal finance in Singapore entitled "Mastering Your Personal Finance"/[如何做个理财掌门人]. His latest book “What Your School Never Taught You About Money” has topped the Straits Times Bestseller list.

[ui21cn]

Yesterday in the Sunday Times Invest page, I read about the article of keen investor and Debt Capital Market expert.

The following wordings really set me thinking about taking the advice from the “experts”

“We have no debt. My husband, despite being regarded as an expert in the Asian debt capital markets, is completely allergic to personal debt.
We paid upfront in full for our house in Australia and our cars.”

I believed fellow friends in the forum have heard and learnt about the good debt and many real life examples about the rich are borrowing to get richer! Should I say more ?

All the best to our Financial Savvy Journey,

Wei Teck

[ngtfook]

I think she does not avocate debt free or having negative view on 'good debt'.
I concur her view on money...

...Money, says Ms Leahy, allows her to do what she is passionate about. "I enjoy making it, spending it and, most of all, giving it to good causes but I don't obsess over it."

She is well aware of possible criticisms of her view.

"You could argue that it's because I'm relatively well-off... but I also know many people wealthier than I am who are racked with anxiety over money issues and the question of 'how much is enough'...

Yesterday in the Sunday Times Invest page, I read about the article of keen investor and Debt Capital Market expert.

The following wordings really set me thinking about taking the advice from the “experts”

“We have no debt. My husband, despite being regarded as an expert in the Asian debt capital markets, is completely allergic to personal debt.
We paid upfront in full for our house in Australia and our cars.”

I believed fellow friends in the forum have heard and learnt about the good debt and many real life examples about the rich are borrowing to get richer! Should I say more ?

All the best to our Financial Savvy Journey,

Wei Teck

[walkinepark]

Debt is good If
1) you know what you are doing and
2) have control over the subsequent payment of the debt

For e.g., imagine we are driving on the road, and we ran out of fuel and money, do we
1) borrow money from someone to pay for a fuel top-up so that we can get to our destination faster or
2) abandon the car and start walking?

If we are very sure that the next destination has a bank, by all means i would borrow the money to top up the fuel.

In essence, knowledge is important if you decides to leverage on debt.


cheers