"Good" Debt Versus "Bad" Debt

[Musicwhiz]

Interesting viewpoint from Andrew Hallam (see link).

http://andrewhallam.com/2010/10/what-do-...in-common/

I recall a certain financial guru who used to visit Wallstraits and Afralug forums - he said that debt was "good debt" if it can be used to invest at higher rates of return than the cost of debt. Therefore, one should pay down a mortgage loan as slowly as possible, and invest the money to gain the difference (spread). Any comments on this?

Then again, someone also recently reminded me that this certain guru was from the mortgage loan industry, so it makes sense that he wants everyone to carry a balance on their mortgage loan for business purpose!

So is carrying a mortgage balance on your "cheap" loan good or bad? Will really welcome comments, viewpoints and opinions please!

[yeokiwi]

Only HDB concessionary loan can be considered as good debt since:
1) The alternative to paying down the loan is 2.5% interest rate in OA account. For the 1st $20000, the rate is 3.5% currently. So, essentially, for those who have less than 20k in CPF account, it is a no brainer to leave the money in CPF.
2) The difference is only 0.1%. Paying down the HDB loan or leaving it in CPF without doing anything probably will not make much difference to the retirement fund.
3) For a reasonably good investor, beating 2.6% is really not difficult in the long term.
4) Some may even transfer the money from OA to SA to enjoy a higher return although I do not think that is a good idea.
5) There is a mortgage insurance in place. If the owner bites the dust, the leftover loan will be covered and the beneficiaries will receive the full quantum of the CPF savings.

Some calculations on the HDB loan repayment...
http://www.valuebuddies.com/thread-328-p...an#pid2997

As for normal bank mortgage loan, a lot of factors will have to be considered. But, the risk is so much higher and most people probably cannot generate 5% return consistently to beat the bank rate.

[KopiKat]

It's like playing with fire. You can get severely burnt if you're unable to control it and let it get out of control!

On the part of that "financial guru" from Wallstraits, I also remembered that he was telling all that if you were to just borrow from HDB at 2.6% and leave your monies earning 2.5% at CPF, you'd still make $$. I think he even showed his chart and figures, which he'd used for his public seminar, as proof that the use of "good debts" can be totally risk-free! That was till a few forummers collectively used correct figures to prove that he was wrong (I think it was 'icewolf' who drove the nail to the coffin with the correct figures) - I really missed those good ol' days..

Subsequently, when that "financial guru" got into the UK TEP biz, he changed his tack to selling the idea that the 5-6% yield from his products are giving enough margin of safety over mortgage interests. But, when the collective power of the good ol' forummers started pointing out risks such as Exchange Rates, he brushed it aside with graphs showing that it was at a historical low (go track how much further UK Pounds had dropped since then). Other risks, such as jurisdiction of claims (troublesome to claim fm UK in case of dispute) was also brushed aside and subsequently claimed by that "guru" to be personal attacks...

IMO, only those who'd been investing and consistently making consistent good returns (with a good margin over the debt interest) thro' market bulls and bears over an extended period of time (10years??) are experienced enough to consider using "good debts". If you are a novice or even one who's unable to make consistent returns from investing, then better to pay down your mortgage asap.

Oh ya, the other thing is, don't get misled by salesmen who'd vested interest in making $$ from you...

[Musicwhiz]

IMO, only those who'd been investing and consistently making consistent good returns (with a good margin over the debt interest) thro' market bulls and bears over an extended period of time (10years??) are experienced enough to consider using "good debts". If you are a novice or even one who's unable to make consistent returns from investing, then better to pay down your mortgage asap.

Wah, frankly I don't even remember so much! But thanks for jogging everyone's memory here of what happened.

I do agree with your statement that only very experienced investors and people who are knowledgeable about personal finance and money management can make use of good debt effectively. Even then, there is still an under-stated, latent risk that things may blow up quickly, suddenly and unexpectedly. Many books on prudent investing do not recommend any form of leverage, but I do not know if this extends to cheap mortgage loans.

yeokiwi, I agree with you on the CPF OA balance - I keep mine low as I am aggressively paying off my remaining mortgage loan but am unsure if this is really the wisest choice as the OA balance <$20,000 is getting 3.5% per annum. The difference is not significant to me as my balance is pretty low anyway, though I keep a buffer of 6 months installment payments just in case. The idea is to pay off the loan then start building my CPF OA to enjoy the 3.5% which will then be compounded.

[flinger]

Hi MW,

I actually think a bit different from you that I do not wish to pay down on a HDB Flat as soon as possible for the following reasons. Maybe I am wrong in my thinking , you can review and tell me if you agree or disagree and where I might be wrong...=) :

As said by yeokiwi :

5) There is a mortgage insurance in place. If the owner bites the dust, the leftover loan will be covered and the beneficiaries will receive the full quantum of the CPF savings."

and also the following personal reasons :

1. In case of retrenchment, as I am in a profession that is unique so it takes time to find another job or have to change my job to fit another field, so having the cash in the CPF OA account removes the worry of paying down mortgage during these times. The mortgage can be continued to be paid by the cash in CPF OA without any issues. If I had aggressively paid down using my CPF and I need to use cash because of retrenchment, it would cause issues.

2. HDB Loan and CPF interest rate is only 0.1 % difference so to me it is a good deal. People talk about opportunity lost if you didn't invest, but that opportunity comes with risk that I don't wish to take as the money is meant for housing.

3. I was thinking on the long run like 20 years due to inflation, the house will still keep its value or grow but I will be paying the mortgage amount in future dollars which is cheaper than paying in today's dollars.

In terms of retirement, if you really want to use CPF, then you should ask to deposit it into CPF - retirement account so you get 4% but my thinking is to use CPF LIFE as one source of stable income for retirement, but not the only source, you definitely need other sources such as savings, dividends, rental etc....

These are my humble opinions, please review and correct me if I am wrong in my assumptions.

[greypiggi]

One example of good debt in my opinion is to use currently cheap credit (ie. debt) to leverage to buy short term bonds which are expiring in 2012, 2013, at worst 2014. For example, XXXX REIT SGD bond expiring in 2013 Feb currently yields about 3%. We use $50K and borrow 200K. leverage 80% which is given by some banks.
Using 1.5 years tenure for easy calculation and 1.5% cost of funds which is about right considering Fed already say no increase until 2013.

Cost of interest = 200,000 * 1.5 *1.5 = $4500.
Total yield upon maturity = 1.5 * 3% * 250000= 11,250
(Commission of bond inside initial quote already)

Actual profit =6750 for 1.5 years using capital of $50K. That is a return of 13.5% over 1.5 years or about 9% annualized return. Say you do about 10 such short term plays and we are talking about using good debt to generate 9% rather risk free yields. Has to be short term bond or else interest rates if were to go up will eat into your gains quickly.

[egghead]

Personally, I don't like to the label of "good" or "bad" being to debt. A debt is something you can use. If you know how to use it well, it helps you to meet your objectives; if you abuse it, you can suffer losses.

My view about money is that when it is in your hand, you can decide what to do with it; once you pay back to the bank, you lose control.

[Jared Seah]

Hello Musicwhiz and friends,

I have shared my experience in using leverage for both property and equities in my 2 blog posts below:

http://singaporemanofleisure.blogspot.co...on-my.html

http://singaporemanofleisure.blogspot.co...r-bad.html


I echo the viewpoint from egghead.

Leverage (like fire) by itself has no "meaning". Whether it's "good" or "bad" lies with the person yielding it. And that will differ from individual to individual.

Just like you can eat healthy and excercise - but still get cancer. And we also know elders who smoke and drink like hell - but have outlived many of their relatives and peers!? How we see the world is from the perspective of our collective personal experiences.

I am not promoting leverage. I just want to cheer making decisions on our own and taking responsibility for them

By the way, that "guru" also promoted land banking. Not only we have exchange rate risks, we now have police case...

The sharing from Andrew Hallam is indeed interesting. But at the end of the day, he is he. I am I. I don't live my life by following others. But I do learn from others' experiences!

I say this with empathy and kindness. That's why for once, I didn't make any wisecracks.

I can be serious too,
Jared Seah

[FFNow]

I think it's just a matter of differing views? I can remember off my head that Robert Kiyosaki and Adam Khoo also differentiated good debt and bad debt. Some view all debt as bad and have to be paid off no matter what like Andrew Hallam while others view some debt as good. Having said that, when interest rates rise, we must not be clobbered by the payments in the so-called good debt. In his book, Andrew said that his mom taught him not to buy a house if he couldn't afford a doubling of interest rate.

[hyom]

I recall a certain financial guru who used to visit Wallstraits and Afralug forums - he said that debt was "good debt" if it can be used to invest at higher rates of return than the cost of debt. Therefore, one should pay down a mortgage loan as slowly as possible, and invest the money to gain the difference (spread). Any comments on this?

Yes, I remember Dennis Ng who has been active in WallStraits since 2004. Then, he and d.o.g were among the most active participants in answering questions from the newbies. However, he got several negatives in his reputation. I guess forummers were not happy as they could sense he had an hidden agenda to promote himself and his business. Sometimes, life works in mysterious ways. d.o.g had no hidden agenda but got a headstart as a fund manager when one of the forummer became his first client. For all his efforts, Dennis got chased off when people get the impression that he is selling koyok. Objectively speaking, I thought most of Dennis's financial advice was sound. Nothing wrong in some self-promotion and marketing after dishing out all the free advice. One has to be paid in some ways for the effort.

Sure, there is good debt and bad debt. If all debt were bad, then we as investors should punish all companies with debt. Debt is good when the debtor is able to use it to grow more money with the odds in his favor. Debt is good when the interest rate is low because the odds are higher in making returns that beat the interest rate -> grow money. Therefore, low-interest mortgage debt is good debt. Debt is definitely bad and even fatal when the interest rate is very high like credit cards and loansharks. Debt is bad and meaningless when used for consumption. If you can't afford something with cash, then don't buy. In my opinion, debt should not be used for consumption and should only be used for investment purposes if one wants to become rich. Using debt for consumption is like incurring risk without investment returns.

Having said the above, I think the most important in assessing good debt and bad debt is still knowing yourself. If a person has poor financial discipline or zero knowledge (none that I know of on this forum), all forms of debt is bad including low-interest mortgage debt.

If a person does not have a good record of managing his finances, the first thing to do with spare money on hand is to pay down debt. Otherwise, if he loses his job and remain unemployed for a extended period of time, debt could potentially bankrupt him. Even if he keeps his job, what if he is miserable in it because he is treated like a slave? With heavy debt, one is as good as being a slave to the job. If he loves his job, fine. If he hates his job, it can cause mental problems like depression. It is for this reason that my top priority is to avoid any form of heavy debt that enslaves me to a job in which I am humiliated or treated unfairly. Those who have suffered under terrible job conditions before (like I did once in the past) will want to ensure that if the same thing happens again, they should have the freedom to show their bosses the middle finger, throw the letter to their faces and walk off like a hero in some Chow Yun Fatt's movie. Shiok! This is what I call financial freedom. And being debt-free is the first step.