How to manage personal debt


Saturday January 9, 2010




THE “easier said than done” phrase latches on to this topic like ants to sugar. While getting into debt is made easier today with the many innovative marketing plans undertaken by financial institutions, getting out of if, leaves much to be pondered.


For those who do not see the light at the end of the tunnel, Bank Negara has introduced AKPK or Credit Counselling and Debt Management Agency. I am assuming a single source of funds being financial institutions, and not “ah-longs” and other unconventional sources.


There is actually one step to be undertaken prior to managing your debt, which is managing your cash flow. It does not mean that if one is a millionaire, there is no need for debt management ... well perhaps there is no need, since the ability to source for debt is high, but everyone will need to manage their cash flow, let it be millionaires or paupers.


Let’s look at some steps that we can take to ensure that we are able to manage our personal debts so that we do not go into the “PN4” or “PN17” status (which for companies implies a financially distressed state).


Let’s start with liquid debts, credit card and car loans. For the former, never follow the minimum payment requirement of the bank, which is 5% of outstanding sum. The reality is that it does not diminish in 20 months (5% X 20 months = 100%) – which is the general misconception.


Instead, spread the payment over a reasonable payable period. For example, if you purchase a personal computer for RM1,500 perhaps, you want to make a RM300 monthly payment over 5 months, rather than pay RM75 in the first month, then RM71 for the second month and so on (assuming one follows the minimum 5% payment, excluding interest charge).


As a matter of fact, if one were to purely pay the 5% minimum payment, do you know that it will take 50 years for the sum to trickle down to RM100. And mind you, even with that, the debt won’t be fully settled.


As for car loan, do not take a hire purchase (HP) contract for more than 5 years. What would a car costing RM80,000 be valued at after 2½ years? Depending on the type of car, continental or eastern, a 5-year HP term will value it at RM40,000 (assuming a simplicity straight line depreciation, 100% hire purchase financing, excluding interest with zero value at the end of the payment term).


Assuming one needed cash,don’t you think it’s easier to find a buyer at RM40,000 compared to if you were to take a 9-year car loan whereby you will need to find a buyer at RM62,222 (remaining loan balance after 2 years for a 9-year HP plan).


Naturally, one would say if not for the 9-year term, he or she will not be able to afford the vehicle ... but that’s exactly the point. If you can’t afford it, then don’t buy it!


Next comes personal loan. Firstly, it baffles me that banks are giving out “clean” loans today, meaning non-collateralised, non-guaranteed loans as personal loans to almost everybody with a monthly pay slip. If you are unable to pay, there is little recourse, as compared to hire-purchase loan, where you may have the option of selling the car. Hence, unless you are sure of the purpose and that the usage of the funds will return a cash flow, do not indulge in one.


Using electronic means via Internet banking and online payment systems is a good way to manage your cash flow. Today many banks have this facility that allows you to also format standing instructions to promptly pay a fixed sum on a particular date towards debt settlement. This will help you ensure that priorities take precedence. Therefore, it’s only the balance cash after settling debts that will be available for disposal.


What will be the comfortable debt to income ratio? Zero is preferable, otherwise a 25% maximum limit of disposable income is recommended. For example, if you had bought the RM80,000 car mentioned earlier, on a 5-year term; assuming a simplified zero interest scheme, you would be paying RM1,333 monthly installment.


Therefore following the 25% debt to income ratio, you should be earning a minimum of RM5,333 per annum. This is after tax and EPF, therefore gross monthly salary should be about RM6,200. So after reading this, do you think you have overspent on your car? There is no under-spending by the way, since the ratio is only an indicator, and I am sure you would probably want to also invest in a housing loan.


You can also increase your capacity to loan, by simply borrowing money to invest where the returns are higher than the cost of funds.


If you can find one an avenue that guarantees this position, then do inform me, I too am curious!


Raymond Roy Tiruchelvam is a former senior manager – economics and investment analysis at an oil and gas outfit.