The Straits Times
www.straitstimes.com
Published on
Apr 07, 2015
How to avoid the
debt trap: Here are 5 rules to follow
By Ariel Lim
SINGAPORE - The
Monetary Authority of Singapore is clamping down on consumer debt, announcing
on Monday tighter limits on the amount of unsecured debt that borrowers can
hold. Unsecured debt is borrowing not backed by any collateral, such as credit
card debt and personal loans.
At the same
time, the Association of Banks in Singapore and Credit Counselling Singapore
unveiled a new repayment assistance scheme to help those over the limit to cut
their debt by allowing them to repay the excess debt at a lower interest rate.
But how can we
avoid the debt trap in the first place?
The Straits
Times spoke to Mr Alfred Chia, chief executive at financial advisory firm
SingCapital Pte Ltd, who gave these ofive rules to follow:
1. Distinguish needs from wants
In Mr Chia's
experience, many people incur excess credit card debt through overspending
because of their inability to tell needs from wants. He raised the example of a
handbag, pointing out that while one may need a bag for daily usage, one only
wants a luxury bag costing thousands of dollars.
2. Prepare for emergencies
Mr Chia noted
that while some people fell into debt through overspending, others had been
trapped by emergency needs such as medical bills, particularly those without
appropriate insurance coverage.
3. Invest wisely
Still others
had lost money to poor investment choices and found themselves indebted, said
Mr Chia.
He warned
investors against using their credit cards for investments as it is risking
borrowed money. Also, he advised investors to gain a good understanding of the
investment product and of the risks they were willing to take before making any
investment.
4. Don't count your chickens before they
hatch
Mr Chia pointed
out that many people fell into the trap of "spending future money".
They relied on expected sources of income such as bonuses and pay increments to
finance future repayments, only to find themselves deep in debt when those
sources were unexpectedly cut off.
He also noted
that even debts that initially seem manageable may rapidly "snowball"
because of compounding interest, which he said was at an average of 25 per
cent.
5. Use the 4321 formula
Mr Chia
prescribes a formula of 4321, which he also abbreviates as LESS:
- Loans,
including housing, car and credit card loans, should not exceed 40 per cent of
one's income.
- Expenses
should not exceed 30 per cent of one's income. They can be covered with credit
cards, but these should be paid off every month.
- One should save
around 20 per cent of one's income on long-term financial goals such as
marriage and retirement planning.
- One should
save around 10 per cent of one's income for insurance coverage for oneself and
one's loved ones.
