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Good debt is always good?

Tuesday, August 7, 2012

I look at debt as a necessary evil. Sometimes, I need that extra help in order to buy something.

Then, do I take as long as I can to repay the debt? Well, in this environment of very low interest rates, the concept of good debt has gained traction. Why not?

The idea of good debt is appealing because it gives us more funds which could possibly generate higher returns than the interest paid on the borrowed funds. What is the catch here? Yes, only if we can use the funds to generate higher returns.

The late Dennis Ng said that the rich always take on debt while the average man tries to be debt free. This is not always true. I know of rich towkays who have so much money in their bank accounts that they would pay for a luxury car in cash instead of taking a car loan! No matter how low the interest rate is on a car loan, it is still some 10x more than what a savings account pays in interest. I also know of average people who are leveraged to the max to capitalise on good debt.

So, who is right and who is wrong?

Recently, UOB came up with a 50 year home loan offer. Khaw Boon Wan has called this a gimmick, advising people not to fall for that and that it doesn't make sense. Now, does it make sense? For someone who is financially savvy and who is able to make his money work much harder, it could possibly make sense.

Personally, I am rather apathetic about the whole matter. There will always be people who are more comfortable with debt. Hey, ask the Americans. Then, there are those who are less comfortable with debt. I have heard of mainland Chinese buying condominium units with cold, hard cash.

Again, who is right and who is wrong? It is really subjective, isn't it?

For people who are proponents of good debt, the pertinent question to ask is whether our money can always make higher returns than the interest paid on the loans? For now, it looks that way. What happens the day the party ends? Are they getting drunk on debt?

For people who are more conservative, the pertinent question to ask is whether they could be short changing themselves by being debt free in this environment of very low interest rates. Of course, if the most sophisticated wealth building tool they know is fixed deposits, staying debt free is the way to go.

Like a friend told me, I have a choice. His intended message was that I have a choice whether or not to embrace good debt. Personally, I understand the concept but I am more comfortable being debt free.

I feigned ignorance and replied: "People who do not have a choice should not be investing in property." With this, I deviated from his line of reasoning that good debt is always good. Instead, I insinuated that people who do not have a choice but to borrow to invest in properties just because of the very low interest rate environment and the perceived future returns should think twice.

Of course, the choice is theirs. ;)


Victor said...

Hi AK,

I swear to God I was thinking about the EXACT same issue as I read your latest blog post. I am debt free right now, but have been wondering whether I should be or not....

I emailed someone about this earlier on. Just got his reply minutes before I read your post:

"Actually, HK rates could go much higher if the US/HK peg is withdrawn and the HK$ is pegged to the Yuan. In that case, HK rates would get close to 6% which prevail in China today. But no one knows when.

When everyone says rates are not going up anytime soon then I know for an absolute fact they are going up, and probably sooner than anyone thinks."

Probably true.... but fixed interest loans or mortgages are available. Anyhow,just wonder what's your view on property investment at this time. HK and Singapore are of course way too expensive, but how about elsewhere, e.g. US or UK?


AK71 said...

Hi Victor,

What a coincidence! Go buy Lok Hup Choi!

Well, people who are proponents of good debt might think you silly to be debt free while others could envy you and would like to be in your shoes.

The situation your friend has described is probably unique to HK but it is a very pertinent consideration. In Singapore, we do not have the ability to adjust interest rates as we choose to have control over exchange rates. With capital allowed to flow in freely, the low interest rate environment here is likely to persist as long as expansionary monetary policies hold sway in major economies elsewhere.

Property prices in Singapore are still rather high and with cheap money aplenty, high prices are likely to be the norm. It is really the low interest rates which are keeping prices bouyant as more marginal buyers join in the fray.

Generally, however, I believe that prices here will soften in the next 2 to 3 years as more projects are completed. It is a simple case of supply being more than demand.

I am not familiar with the real estate markets in HK, US or UK. So, I can't comment. However, wherever we choose to buy an investment property, we should have the means to avoid foreclosure. Of course, in certain instances, foreclosure could be a good thing but that is another topic. :)

SnOOpy168 said...

debt, taxes & death. Unavoidable in life, even if born with a silver spoon.

still, like having dividends income for not doing anything else much, not having to face a monthly repayment feels VERY good.

debt can be double edged sword. If done correctly, then the multiplier effect kicks in. i.e. a nett gain from deduction of all interest and expenses. Otherwise, each day may be a sleepless night, wondering how to take care of the next payment.

Saw a chart the other day that if the interest for home loan rises by 0.x %, the monthly payment jumps by $400-500. For some, it is pocket change, for others it is nightmare.

50 years housing loan ? Sounds like a mid-term disaster waiting to happen (interest rate goes up). Perhaps that's the hint to pick up a distress property at a bargain price. Recharging my cash position as much as I can. Maggie / 公仔 noodles anyone ? heheheh

AK71 said...

Hi SnOOpy168,

Indeed, debt is a double edged sword. Everyone should be prudent when it comes to debt.

Debt is a tool which can be used to help build a better life. However, it could also destroy lives.

I remember how my dad's friend who owned 4 condominium units in the 80s almost went bankrupt in the recession then. Property values fell and tenants were hard to find. Through it all, he had to service the massive loans.

My own parents who bought a condominium unit in the 90s lived with a 35% plunge in property value during the Asian Financial Crisis. We were lucky because we could make full repayment and did not get into financial difficulties. The condo's value only recovered fully sometime last year.

A client of mine whose family made their fortune in real estate told me that Singaporeans never learn. Property market is cyclical and there will be a correction in price. It is a matter of time.

People who are relying heavily on debt to buy investment properties in Singapore now could be walking on thin ice.

Kyran Tan said...

I still remember buying my first luxury watch to reward myself after a bonus. It cost $4k plus and although I am able to pay off at one go with my bonus, I chose a credit card instalment plan of 24 mths since it is 0% inaterest . With that I only need to pay a nominal amount every mth. For me this is considered as a good debt.

AK71 said...

Hi Kyran,

If you were able to put the $4K plus to more productive use in that 24 months, it would be considered good debt. :)

My very first purchase of a luxury watch was a Tissot in 2002. A Euro Limited Edition, it remains in mint condition as I have not worn it at all. It is kept in a winder now.

I must admit that I bought it with possible capital appreciation in mind. It was an investment. I am incorrigible, I know.

P.S. A friend told me that Tissot is not a luxury brand.

Anonymous said...

Hi AK71,
Me & wife had experience of good debt more than once.
But this was actually a loan- privilege of the companies we worked for.
The companies loaned us $ FOI for buying car/house renovation while our $ collecting prevalent interest from the bank.
This privilege was only applicable as long as we worked for the company.
So even this real "good debt" could become a liability if we were out of the company and we didn't have $ reserved to pay back the balance of the loan. You bet we had.
So really there is no "free lunch".

AK71 said...

Hi Temperament,

You had the ultimate best deal! An interest free loan is definitely the best possible deal anyone could hope for. :)

I wonder if there are companies these days still providing interest free loans to their employees...

Kyran Tan said...

Haha actually being employees has a fair share of benefits sometimes. Differs from companies to companies. And Yes AK, I believe if we are able to keep more cash on hand instead of having to pay the entire amount at one go, then there could be other opportunities to capitalise on ;)

Anonymous said...

I believe you may have misunderstood Dennis Ng. He for one, don't own a car, and is a strong beliver of BMW (Bus, Mrt, Walk).

So to him, car loan is a bad debt, as it is a flat rate interest, where the effective interest rate is always 2x or more of the stated interest rate of the car loan.

He, however, believe in good debt like housing loan, as most of the rich, borrow against an asset like property with low interest rate, and uses that sum of money to make either capital gain, or a much higher dividend earned that the loan interest rate. This brings about an increase in wealth for the savvy, and capable investor.

Of course, good debt is only good, if you use it wisely, and able to monetise it effectively.

AK71 said...

Hi Kyran,

Yes, we truly appreciate having more money in the kitty when Mr. Market suffers from severe depression. ;)

AK71 said...

Hi SC,

Indeed, Dennis never did believe in paying for a car in Singapore. Thanks for pointing that out. :)

My understanding of good debt is somewhat less restrictive. If we are able to take a loan to buy something instead of paying for it with our own money and if we are able to make our money work harder to offset the interest paid on the borrowed money, it is good debt.

We have to be careful though. Too much of a good thing is never good. That is what this blog post aims to highlight. :)

meesiam said...


Once a businessman told me, debt help him to multiply his weath. With 20$ bank lent you 80$. Then borrow against the 20$ again...just roll n roll.. is debt bad? It is when greed comes in.

INVS 2.0 said...

Hi Ak71,

Speaking of car loan, I was told that 80% of CAT B & E buyers actually paid in cash, with only 20% on 7 - 10 yrs of loan. Is this a wise decision? They could invest the cash while taking out a loan.

AK71 said...

Hi meesiam,

As investors, we know the power of leveraging. We know that a company that is doing well in a growth industry could leverage up and do even better, everything else remaining constant. Similarly, we could leverage up and invest even more in these companies and hope to do even better.

Debt is not necessarily a bad thing but that is not to say that being debt free is silly either.

Personally, I want to be happy in life and I want everyone to be happy in life. Now, if being rich equals to being happy, then, I want to be rich in life and I want everyone to be rich in life. However, is being rich being happy?

AK71 said...

Hi INVS 2.0,

This is just an example of why I say that the rich do not always borrow. They have the ability and they do pay for big ticket items fully in cash.

Marc Faber famously said that the rich in Asia are heavily invested in real estate but they have very little debt. I remember a friend's tycoon father who paid cash for a $14m GCB in Singapore during the Asian Financial Crisis.

Debt is a useful tool for those who are trying to be richer. Of course, the rich could also use debt to be richer than they already are.

However, the Chinese mentality has always been that debt is something of a necessary evil. We borrow if we have to fill needs and not if we have to fill wants. We are mostly savers.

Of course, mindsets change over time. Rich dad, poor dad, anyone?

Gark said...

Debt/Leverage is a doubled edge sword, especially when it comes to investment.

If you made the right call, you can multiply your profits quickly.

But if you made the wrong call, you losses will also multiply very quickly.

Some people I know is now leveraging their debt (from re-mortgage which is cheap) into REITs and the dividends is enough to service their monthly loan payment. At the end of thier loan, they will have free REIT with capital appreciation.

However most are prudent and will not exceed 50%-70% debt to asset ratio. This is because you still need holding power when things turns bad and you need to service your loan during poor economic times (or sell units).

IMHO this is better leverage of debt as the investment is more or less conservative and you can liquidate quickly. :)

Cory said...

I believe the Car logic of Dennis Ng is very similar to what you have stated in essence.

Most young people cannot get enough returns and likely zero/negative versus opportunity costs. The very seeds money needed to buildup investment learning and speed up wealth creation curve.

What i remember last time during previous forum time is he takes Taxi and save the hassle. He probably in middle path already. :P

When one is Multi-Millionaire, a car will be nice even if the returns doesn't work out. Is more of a luxury item.

There will be exception for some people who already earning a lot when young. But then to have car or not is just a good problem to have.

AK71 said...

Hi Gark,

You know some financially savvy people. Being conservatively leveraged sounds like a good middle path. :)

However, your friends will have to bear in mind that they are leveraging to invest in a leveraged product. In a low interest rate environment, it would seem safe enough.

Must keep their ears on the ground for when things change as they could change rapidly.

AK71 said...

Hi Cory,

A car is a necessity for some and a convenience for most. Some would view it as a luxury in the latter instance.

When people are married with kids, a car becomes more of a necessity. For Dennis who stayed carless even with kids, I am sure there were times when having a car would have made things much easier.

This is nothing to do with good or bad debt. Simply put, life is about more than wealth building. A single mindedness to become financially rich could impoverish us in other aspects.

Of course, we make our own choices in life. :)

mark said...

Oh dear. My first luxury watch is almost 5 figure. I do intend to keep and wear it for life. Thankfully i am not a watch freak unlike some peers around me.
Was it a wise move? I dont know. It was to mark a particular milestone in my life.
I too, took a 24 month installment plan. 0%. I was nicely surprised that this particular credit card, gave me points despite it being on installment. The other cards dont give me this.
I redeemed for vouchers. Some 50 bucks worth or so.

AK71 said...

Hi Mark,

Wah! Takai des ne!

The highest watch related expense for me was for a pre-owned Rolex. I got it for $3,300 and sent it to Rolex Centre to have it refurbished and certified for another $1,700 or so. Then, I gave it to my dad as a birthday present.

A brand new Rolex in that style would have set me back by $14,000. So, to me, it was a good deal. ;p

Sometimes, it is worthwhile spending more money to mark special occassions. So, I understand where you are coming from when you bought that luxury watch as you hit a milestone in life. :)

AK71 said...

We retain our negative view on the Singapore residential sector as we continue to see a rising threat of vacancy with an acceleration in physical completions in 2013-15.

Vacancy rates for non-landed private units had increased from 5.9% to 6.1% qoq in 3Q12 as take-up continued to lag physical completions.

URA estimates that completions will rise from 16.1k units in 2013 to 23.1k units in 2015, 2-3x more than the historical average occupancy rate of 8k units per year.

CIMB, 27 Nov 2012.

AK71 said...

According to Nomura on 21 Nov, non-landed private housing vacancy could rise from 6.9% now to 10.9% by end-2013.

AK71 said...

Christine Li, research head at OrangeTee, said: "We know that developers are not ready to slash prices. because even with a 5 per cent discount, not many buyers can qualify for the loan quantum they want."

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