Success Concepts chief executive officer Joyce Chuah
WHILE the concept of debt management may sound simple enough, it is more often than not, easier said than done.
We’ve all heard the horror stories of individuals being declared bankrupt, getting chased by loan sharks or having their homes foreclosed.
All of that can be avoided with proper financial planning and budgeting.
Accumulating too much debt
While debt in itself can be a useful tool to help a person purchase big-ticket items, the important question to ask is, “How much is too much debt?”
Whitman Independent Advisors founder and managing director Yap Ming Hui said a good way to gauge a person’s level of debt is to determine their debt-to-income ratio.
“To determine this, we look at an individual’s monthly gross income and amount of debt that needs to be serviced each month.
“If the debt ratio is less than 30% of your monthly gross income, it’s an acceptable limit of debt. If it’s more than 30%, then it’s considered alarming levels already,” he told StarBiz.
Success Concepts chief executive officer Joyce Chuah said a person’s debt-to-income ratio should not exceed 40%.
“This ratio is akin to the debt-to-service ratio adopted by banks for loan applications.
“However, different banks will have different qualifying debt-to-service ratio hurdles and criteria in calculating the ratio.”
Nevertheless, not everyone can or will be able to comply within the 30%-to-40% debt-to-service ratio rule.
So what happens if you do end up taking on more debt than you should?
Chuah said it would depend on the type of debt.
“It depends on whether it is a good or bad debt, similar to good and bad cholesterol.”
To clarify the difference, Chuah said a good debt puts money into your pockets, while a bad one takes money out of it.
“Hence, if the debt concerns a bad loan like a credit card debt, avoid it at all costs.
“If it concerns a good debt such as a mortgage loan for an investment property or a loan for a fixed-income investment with favourable dividend rates over the cost of your loan (such as an Amanah Saham Bumiputera loan), capitalise on the loan to the maximum limit allowable by the bank.”
Chuah qualified that this is on the proviso that a person’s cash flow can support the difference between the repayments and dividends or rental income.
“This is especially in situations when your loan interest rates are adjusted upwards and your rental or dividends are no longer as sustainable as before to support the repayments.
“Many people have experienced this over the last one year when the overnight policy rate was increased by Bank Negara,” she said.
Managing credit card debt
According to Statista, an online platform specialising in market and consumer data, the transaction value of credit cards in Malaysia amounted to more than RM177bil in 2022, an increase from RM138bil in the previous year.
As consumers continue to loosen their purse strings to spend more, many end up having exorbitantly high credit card debts.
Excellentte Consultancy Sdn Bhd’s Jeremy Tan said one should work on paying off their credit card debt as soon and as quickly as they can.
“Once you have taken on credit card debt, do not take on an additional (credit) card. Stop using your existing card and pay either by cash or using a debit card for payment.
“Do not use the credit card when it is accruing as all new transactions will be levied with an interest charge.”
For those with multiple credit card debts, Tan said it is best to pay off the one with the highest interest rate.
“Make sure you continue to pay for the others too, at least meeting with the minimum payment amount.”
Where possible, Tan advises that one should try to pay off their credit card debts in full within the payment due date.
“Should you need to use a credit card to pay for a big-ticket item, make sure you have the money to pay it off,” he said.
To prevent having credit card debt, Yap said one should just avoid getting a credit card in the first place.
“Prevention is still the best option. If you must get one, be careful with what you are being offered.
“Unlike in the past, today, credit cards are offered to individuals, especially youths, without many pre-conditions. Try to also limit the number of credit cards that you have.”
For those that have already taken on a significant amount of credit card debt, Chuah said one should reflect and evaluate how the situation can be avoided in the future.
“Ask yourself what caused you to have this credit card debt. Was it a once-off situation to pay for an emergency, such as an unexpected medical condition, or an accident?
“Or was it chalked up due to toxic financial habits such as shopping, gambling, over-trading, getting scammed because of greed, herding or even ignorance.”
For those with multiple credit card debt, Chuah said he or she should first rank them from the most expensive to the least according to the interest rate.
“Then, rank them by the outstanding sum payable. Next, list all your assets and rank them according to how quickly you can liquidate them. Assets can be bank accounts, shares, unit trusts, insurance cash values, equity in your mortgage loans or valuable personal items.”
She added that an individual should then pay down the first credit card debt, starting with the most expensive and smallest debt.
“The logic is to reduce the number of credit card debts and remove them from your list as quickly as you can. Starting with a small one allows you to quickly get them off your list.
“Then, close the account immediately after full settlement. Opt for a debit card instead.”
Improving your credit score
Having a good credit score is an important component of an individual’s debt management habits.
Tan said a credit score is a measurement of an individual’s capacity to pay off existing debt.
“This can be a housing loan, a personal loan or hire purchase loan. All of this can affect an individual’s ability to get another loan.
“In some countries, it is used as a measurement whether the individual is likely to be able to rent a premise too. In short, it can affect your access to credit,” he said.
Chuah elaborated that a credit score is a record of a person’s historical debt repayments over the last 12 months.
“It tells the banking institutions if you are a ‘trustworthy’ borrower in terms of timely repayments and if they should extend a credit facility to you based on your past repayment records.”
Chuah added that having no records of any loan repayments can also be detrimental, as a lender will not have any data to refer to regarding an individual’s repayment track record.
“So, it is best to have at least one loan that you can service well.”
Tan said the simplest and best way for an individual to improve their credit score is to pay off their debts on time. “Whether it is a housing, car or personal loan, credit card debt or utility bill, just pay them on time.”
If there are any disputes with regards to the repayments, Chuah said it is best to try and settle any outstanding debt as soon as possible.
“You can pay under protest first and settle the matter later.
“Do not be scammed by ‘investment gurus’ who may entice you to get numerous loans with the promise of attractive returns. You may just end up with a bad credit score or be made bankrupt,” said Chuah.
She added that an individual also should not get a loan for investments that do not promise fixed returns.
“This applies to investments on properties, commodities or equities. Get help from professionals or a friend to be there alongside you so that there is accountability towards your plan to improve your credit score,” Chuah said.
