I believe you would heard of the definition of Good Debt Vs Bad Debt and why you should avoid bad debt and take only the good debt. For the benefit of readers who aren’t sure, a short description is provided here:
Good Debt: Borrowing to invest our purchase assets that are either income generating and/or potential of capital appreciation. Examples of such loans are house loans and loans for stock investment.
Bad Debt: Borrowing to purchase mainly consumer goods that has neither income generating ability nor the potential of capital appreciation. Examples of such loans are credit cards loans and car loans.
1. Good debt doesn’t mean you take them without prudence!
In this world, there is no such thing as a guarantee earning. Think about it, even the job you are holding might not be a stable one, the company might face crisis and needed to laid off staffs or suffered a pay cut etc. So what’s make you think that the investment you are going to make is going to be absolute risk free and a sure win?
I am worried when I read an article on Singapore debt levels ‘among highest in Asia’, where it was reported that Singapore households are among the most indebted in Asia relative to what they earn in which households had borrowings worth 151 per cent of their annual income last year! One possible reason is that Singaporeans borrow from banks in order to get a slice in the property investment/rental market.
2. When Good Debt Turns Bad!
So let’s take an example of what is hot in Singapore, the property market, to illustrate my point of good debt turns bad. You might think what could go wrong with taking on a good debt for a new condominium for potential rental income benefits especially Singapore where it’s land is scarce?
– When your property is vacant for a long period of time.
I know you did your calculation and is confident that whatever you collected as rent is more than whatever you need to pay for your rent. However, did you consider what if your property remain vacant for pro-longed period of time due to low demand in rental market? You will need still need to pay for the monthly instalments with interest. Not only that, in the midst of finding a suitable tenant, you will need to pay for the agent fees and any advertising fees. All this will sum up to a huge sum of money and the effect will be detrimental to your cash flow if you are not prepared for it!
– A spike in interest rates
Currently, we are in an unprecedented low-interest rate environment (of about ~0.588 SIBOR, house loan hovering at around 1.6-1.8%). This has encouraged excessive borrowing which the borrower has the wrong impression that they could afford it well. But what if situation starts to change? The US decided to execute its tapering and interest rate start to spike sharply to say about 3-4%? This innocence jump of 1.5% is enough to cause a significant different in your near million or millions dollars loan.
– Valuation of your property falls
Right now, Singapore government has been actively in introducing cooling measures in property market. The latest being a total debt service ratio (TDSR) of 60%. This TDSR of 60% means that the total debt of borrowers cannot be more than 60 % of their income. This will definitely reduces the demand of property in the market to a certain extent. Fundamental economics states that with demand drop and supply increases, the price of the goods will fall. Hence this will affect the price of your property.
You might be wondering, so what if it got to do with me? I am not going to sell until the price is right! But aha! There is something you need to be aware of the term and condition: Loan to Valuation (LTV) which you agreed with the bank when you signed upon the dotted line for a loan. Typically, the bank will offer a 80% loan based on the valuation of your property (60% for 2nd property). Hence, a fall in valuation will mean, you will get margin call from the bank to request for a payment of the difference. If you are not prepare for this, it will definitely give you a shock as the sum could easily compute to be a 6-digits figure!
In conclusion, I would like to create an awareness that although there is a clear definition of what’s a good debt and what’s a bad debt, it doesn’t mean we should all take up all the good debts that we are possibly eligible for. Think of what could go wrong during the loan period and ask yourself if you are able to stomach it.
Most importantly, invest prudently too! Do not overstretch yourself (or your dollars) too much. Just like you are able to work 18 hours daily, doesn’t mean you have to unless really necessary.