Debt’s amore?
Question: I am so hesitant with borrowing money. I have heard horror stories of people being burdened by monthly amortizations with some even being hunted down by collectors. Yet I am told that I would need a good credit score. Is establishing a good credit score really that important? Asked at “Ask a Friend, Ask Efren” free service at www.personalfinance.ph, SMS, Viber, Twitter, LinkedIn, WhatsApp, Instagram and Facebook
Answer: A person’s credit score is used to evaluate the probability that he will pay back his debt on time. Some of the benefits of a good credit score are: access to low-interest rates on credit cards and loans; more borrower negotiating power; higher chance of credit card and loan approval, and approval of higher credit limits.
But please understand debt is not a necessity but a mere option. “An option to what?,” you ask.
Look at it this way. Just as we need capital to start, grow and maintain a business, so too do we need assets to start, grow and maintain our household finance. Ideally, the majority of these assets need to be earning as well, especially early in life.
There are only two ways to fund the acquisition of assets—by using our own money and by using other people’s money or, in other words, by contracting debt. If you are able to save a good portion of your income throughout life by not succumbing to laziness and religiously follow a sensible cash flow budget, there is a good chance you will not need to resort to borrowing to acquire asset or occasionally enjoy some of the luxuries in life.
You can own a home without the loan and fund emergencies from your cash for contingencies. But while debt is an option, some marketers use it as a love potion to lead you into enjoying things now and not after several years of being wise with your money.
Believe you me, lenders will pounce upon a person who has the capacity to repay even just based on his cash hoard without even looking at his future income stream. That is the whole foundation for back-to-back loans that use cash as collateral. Plus, nowadays, creditworthiness is not just based on whether you had been paying your monthly loan amortizations on time. Creditworthiness, especially for a person who has not borrowed a single centavo in his life, can be based on how prompt he has been paying his utility bills.
Please do not think that I am saying that debt is the mother of all evils. When wisely used, debt can serve as a multiplier to earnings provided such earnings are large enough to offset the size of possible losses and the cash outflow from principal and interest payments.
Are there rules of thumb in acquiring debt? Three come to mind. One is that the repayment of consumer debt should not amount to more than 20 percent of net monthly income. Another is that housing loan amortization should not exceed 20 percent of gross monthly income. While a third states that the total loan amortizations for all household debt should be no more than 36 percent of gross monthly pay. But remember, these are but rules of thumb. It would be best to really analyze your finances better to see what amount of debt you should contract, not per se but as a tool to reach your long-term goals.
Debt’s amore? Well, when huge debt hits your eye like a big pizza pie, that’s a black eye to your finances. INQ
Efren Ll. Cruz is a registered financial planner of RFP Philippines, seasoned investment adviser, bestselling author of personal finance books in the Philippines. Become a Yaman coach. For details, email [email protected]. To learn more about personal financial planning, attend the 90th RFP Program this June 2021. To inquire, email [email protected] or text at 0917-6248110
