Be Careful with Debts

(Sumber : Azizi Ali Newsletter October 2011)

Every now and then I would receive a question on mortgage refinancing.“Azizi, should I refinance my mortgage?” They would ask. “I took a mortgage 10 years ago when the interest rate was 6.75 percent. Now that the interest rate has gone down, I want to refinance the mortgage so that my monthly repayments would drop. This will help ease my cash flow. Furthermore, as the value of my house has gone up considerably, I can get a much higher mortgage, which means I will have some money for investments. What do you think of the idea?” Though the details about the interest rate and the period may differ, the point of the questions remained the same – should they refinance the mortgage to take advantage of the low interest rate and also the rise in value of their property?

In other words, should they take on a new larger debt? I told them that the answer is yes and no!Let me explain the ‘yes’ part first. Yes, they should refinance if the intention is to take advantage of the current low interest rate. By doing so, their monthly repayments would drop (assuming that the loan amount remains the same, of course). Generally speaking, you should consider refinancing your mortgage if the interest rate drops by 2 percent or more from the rate that you are currently paying. Of course, to be sure about the whole thing, just add up all the charges, such as stamp duty and legal fees (if applicable) to the total repayments for the new mortgage, and then compare it with the total repayments from your current mortgage. If the figure from the new mortgage is lower, then ‘yes’, you should do the refinancing. If the answer is otherwise, then obviously, you would be better off sticking with the current mortgage. At the same time, you also need to look beyond the numbers. You must also consider the terms and conditions of the new mortgage. Needless to say, they should also be better than your current mortgage.

Now, we’ll move on to the ‘no’ part. I’ve discovered that the reason why most people refinanced their properties is not because they want to take advantage of the lower interest rate. Actually, it is because they want to out the equity from the property. As the value of their property has gone up considerably in the last couple of years, it means that their equity has gone up considerably as well. After seeing their neighbours living the good life – vacations, new furniture and fancy cars – from the cash received from the refinancing, encouraged by well meaning (though no experts on money matters) workmates and cajoled by smiling loan officers, it is little wonder that a lot of people cannot sit down still! The thought of having all that extra cash to spend is burning their behind!

Of course, they justify it by saying that they are going to use part of that money to make investments. “I’ll use it as seed money to invest in shares, business and gold,” they would tell me. Now if they actually did that, i.e. find an investment that pays a return higher than the interest charged, things would not be so bad. But the reality is that it is not so easy to find an investment that pays a return higher than the interest charged for the loan. To compound matters, most people know very little about investments. As a result of this, instead of making money, they often lose money from their investments. So this is why I often answer ‘no’ to the question. No, they should not refinance if the intention is to take out the equity from the property. And why not? Because; (1) they would increase their debt level as the new mortgage is larger; (2) their monthly repayments would also increase as a result of (1); and (3) chances are they will blow much of that cash in no time at all.

Now we’ve come to the bigger question: How come I’m just about the only person (aside from the folks at AKPK) cautioning you about taking on new and bigger debts? The answer is that the others (loans officers and financial institutions) want you to get into debt! They make money, lots of money, whenever you and I do so. First of all, the loans officers get a fat commission every time our loan is approved. Next, the financial institutions are happy as they have just added your name to their long list of people who just volunteered to work hard for the next 20 years to make them richer! Hey, I would also encourage you to borrow money if such a deal is at stake!

Of course, this is not to say do not borrow money (though that wouldn’t be a bad idea). You would probably need to take on debt to buy properties (not too many of us can afford to pay cash for a property worth half a million ringgit). Borrow yes, but make sure that you can afford to pay the mortgage on a consistent basis without having to sacrifice much else. Next, make sure that you can still afford to do so when interest rate rises (and they will rise). Actually, there is nothing quite like borrowing money. When times are good and the value of your investments rise, you will look like a genius to the power of infinity by using borrowed money. Tragically, the same debt will cut you into a thousand pieces when the tide turns. I once attended a talk given by our former finance minister, Tun Daim Zainuddin, some years ago. He told a story about one of his colleagues who was so high flying during the good times that he was termed as having the Midas touch – a real life Superstar! Practically everything he touched, particularly stocks, rose in value. Banks were lining up at his office to offer him their money!

However, when the Currency Crisis blew into South East Asia, the tide turned and turned so suddenly that it caught a lot of people cold, including the Superstar. As the stock market dived, his shares were forced sold, and he still owed millions. The good thing is that banks were still lining up at his office. However, this time they were demanding for their money back!I hope I will never forget the story. If a smart, high-flying, well-connected and super rich guy can get caught because of debt, what more ordinary mortals? As my friends at AKPK would say – be careful of debts. As for me – I only borrow money to buy appreciating assets, and only in manageable amounts. If I do not have the money to buy something, then I sit in the house quietly!

Copyright © Azizi Ali 2011

My opinion : Simple je. Consider carefully good debt. Jangan over leverage. Monitor BLR.

Try hard to avoid bad debt.