Smart Borrowing: Achieving Financial Independence and Avoiding Pitfalls

By Agensi Kaunseling dan Pengurusan Kredit (AKPK)

The purpose of borrowing:

If you are thinking about taking a loan, it is important to reflect on the purpose behind it. Are you borrowing to invest in your education, buy a property, or fund your holiday or wedding? This will help you determine whether taking this loan is really a necessity, or not.

Because when it comes to loans, they vary in terms of risk and reward. Generally, they can be categorised into good debt or bad debt.

Many consumers believe they are assessing their affordability carefully, but some may not be applying a structured financial management approach. This is evident from our 2022 survey findings — 4 out of 10 consumers did not plan their spending, 5 out of 10 did not spend according to their plan, and 6 out of 10 did not record their spending.

Source: AKPK Survey in 2022: Rebuilding Financial Resilience: What Consumers Can Learn from the Pandemic

Good debt refers to low-interest loans that can increase in value and add to your overall financial health in the long run. Loans that are taken for education purposes and a housing loan are examples of these. This is because investing in an education can lead to better job opportunities, while properties tend to go up in value over time.

According to the AKPK survey in 2018 on Malaysian Working Adults (MWAs), a significant 28% of individuals need to borrow money to purchase essential goods, with 21% of these borrowers relying on non-bank institutions, which often come with higher interest rates and less favourable terms. This borrowing tendency is more prevalent among males, the self-employed, and those earning less than RM2,000, groups that are likely to face irregular income or limited financial resources.

Source: AKPK Survey in 2018: Financial Behaviour and State of Financial Well-Being of Malaysian Working Adults

Bad debt, on the other hand, is usually taken for non-essential purchases. Credit cards and Buy Now Pay Later (BNPL), which often come with high interest rates if payments are made late, are commonly used for lifestyle expenses like vacations and fashion, making them a form of bad debt. The fear of missing out (FOMO) and the desire to keep up with others can drive people to spend money on things they don’t really need or sometimes even want, such as getting the latest gadget or dining at an expensive restaurant, to avoid feeling left behind.

According to the same AKPK survey in 2022, 3 out of 10 respondents were categorised as compulsive online spenders, exposing them to financial vulnerability.

Source: AKPK Survey in 2022: Rebuilding Financial Resilience: What Consumers Can Learn from the Pandemic

Some people also take personal loans to finance their weddings. While such celebrations may feel like once-in-a-lifetime events, consider whether it’s worth going into years of debt just for a week-long occasion.

Repayment capacity and ability

If you are uncertain about how much you can afford to borrow, a helpful guideline is the debt service ratio (DSR). This ratio calculates how much debt you can take on, in relation to your income, which helps you estimate how much you can borrow.

First, add all your monthly debt payments. This includes rent, car loans, education loans and even BNPL obligations. Next, determine your gross monthly income, which is how much you make before income tax deductions. Lastly, use the formula below to calculate your DSR:

 

Debt Service Ratio

Ratios below 35% is generally considered good, while ratios exceeding 43% may indicate that you are taking on too much debt in relation to your income.

For example, if you earn RM3,000 and your monthly debt payment is RM1,100 (rent) + RM500 (car loan) + RM500 (credit card), your DSR will be 70%.

 

 

Sample DSR Calculation

A DSR of 70% is very high. It means you are spending 70% of your income just to cover debt payments. This leaves very little money for other expenses and obligations such as food, savings and investments.

It is also important to understand the interest rate and the total interest you will pay over the entire tenure of your loan. Calculating the total interest gives you a clearer picture of the long-term costs, which can significantly influence your monthly payments and your overall savings.

For example, if you purchase a property for RM500,000 and take a 100% loan at a 4% interest rate over a 35-year tenure, by the end of your tenure, you would have paid a total of RM920,840.61! This means you’ll be paying RM420,0840.61 in interest alone. To reduce your total interest, you might want to shorten the loan tenure or make a downpayment.

And if you are unsure about how to calculate this, don’t worry! There are plenty of free tools available online that can assist you, so you don’t have to crack your head doing these calculations manually.

Similarly, if you owe RM8,000 on your credit card with an 18% annual percentage rate (APR) and you decide to repay RM200 every month, it will take you approximately 5 years and 2 months to pay off the balance, resulting in a total interest payment of RM4,308.98.

These situations highlight the importance of considering how such loans can affect your long-term financial goals. Will paying a 35-year loan tie you down and restrict you from doing other things you enjoy such as travel?

Existing commitments, including financial loans

While you can use the debt-to-income ratio to estimate how much of your income can go towards paying off a loan, everyone’s financial situation is different.

For instance, if you are supporting children and your elderly parents, you may have less money left at the end of every month. In such cases, it is important to take a closer look at your finances. This could mean that you might have to consider taking a smaller loan amount or opt for a longer repayment period.

Start by listing down how much you currently spend every month on expenses such as rent, bills and any other loans you are currently paying. Remember to include occasional expenses as well, like home repairs or sports equipment. This will give you a clearer picture of your remaining funds and help you determine a realistic loan amount.

By fully understanding all your financial responsibilities, you can make more informed decisions on whether taking a loan is sustainable or even necessary for you.

If you are still unsure about whether you can afford to take on a loan, or how much loan you can realistically manage, it’s a good idea to seek guidance from a legitimate institution like AKPK. We offer free financial management advice and solutions to households and MSMEs (Micro, Small, and Medium Enterprises).

You can book an appointment online at mybijakkewangan.akpk.org.my or visit our nearest branch to get personalised assistance from our registered financial advisors.

However, when seeking financial advice, always be cautious of potential scams. Remember that AKPK does not appoint any third-party agents, and all our services are completely free of charge.