Is there such a thing as ‘good’ debt? We ask Andrew Talbot from Expat Financial Planning, a division of Global Eye. He’s one of the only Expat Certified Financial Planners (CFP) in Singapore and a member of the Financial Planning Association of Singapore, so he’s very much ‘in the know’!
Pop quiz… you have a credit card balance of £3,000 at an APR of 17.9 per cent. How long will it take you to clear it if you ONLY make the minimum repayment each month (as a guide, 1% of the outstanding balance plus interest) and HOW MUCH will you pay in interest?
Over 10 years and £1,000 in interest
Over 15 years and £3,000 in interest
Over 27 years and almost £4,000 in interest
This was a personal financial quiz that was in the Financial Times a few weeks ago (the answer is at the bottom of the page).
What’s worth getting into debt for?
There are some things that are worth going into debt for; a mortgage, a student loan, investing in your business or purchasing a car. These investments generally leave you better off over the long term and don’t have a negative impact on your finances. You should always make sure you are borrowing at the cheapest rate and that you can handle any increase in payments. In the current low interest rate environment, there is high probability that rates will rise so you should understand the risks and implications if this happens.
What about bad debts?
Bad debts are those that drain your wealth, are not affordable and won’t pay for themselves in the long term. If you can’t pay off the money in the short term then you should probably not spend the money. The big example is not paying your credit card off at the end of the month. It’s very easy to get into an expensive expat lifestyle by trying to keep up with the Joneses. Using debt to fund this is never going to help your finances. Always ask yourself, will borrowing this money improve your finances in the long term?
Should you reduce your ‘good’ debt? For instance, by overpaying on your mortgage?
It can make a lot of financial sense because it shortens the mortgage term and reduces the overall amount of interest you pay.
For example, on a 25-year £250,000 mortgage with an interest rate of 3.5%, if you were to overpay by £200 a month you would save £27,701 in interest and pay off the mortgage five years earlier.
There may be penalties for early repayment, so you must check with your lender. It may be that you are allowed to make some overpayments provided you don’t repay more than 10% of your outstanding loan in any one year. It is also worth considering any tax breaks that may occur, in Australia there are tax benefits to having a ‘negatively geared’ property.
In the current environment, finding a savings account which will earn a higher rate of interest than you are paying on your mortgage is highly unlikely. Interest rates around the world are very low and it’s also worth shopping around to get a lower mortgage interest rate
Repaying ‘good’ debt also depends on the shape of the rest of your finances. Repaying your credit card or a personal loan first, would make more sense than overpaying on your mortgage because credit cards and personal loans have a higher rate of interest than mortgages.
Top tip
It is also good financial planning to build up a financial cushion – of an amount equivalent to three to six months’ income – to fall back on in emergencies, instead of overpaying.
Prudent financial planning is to reduce all debt whether ‘good’ or ‘bad’ but it’s great financial planning to reduce the bad debt first.
*The answer to the question is C. It would take you 27 years to pay back the debt and pay £4,000 in interest.
Need help getting your personal financial affairs in place? Visit www.expatfinancialplanning.com for more information on the different types of cover available and what level you require, as well as useful financial planning guides including Will I have enough to retire?, How to get into the savings habit, Sending Money Overseas, and more.
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