WHO IS LENDING MONEY?

Who is lending money?

Introduction

The question of who will lend you money in times of need is not too difficult to answer. Of course the easiest and often, with little formalities, would be our parents. However, don’t tap on them too much unless they are super-rich, as they would have alternative arrangements for their old age. There are many financial calculators you could access on the internet which will roughly work out as to how much you need to sustain a reasonable life style after retirement at about 60 years (have you enough money to retire?).

Friends and relatives may be worthy of a trial, but when the request is turned down or when repayments are delayed the relationship would sour and you ‘may lose that relationship’.

Of course saving for the financial need may be a way out, that is the conventional way, but in most instances it would not be possible. If you want to start a business there us a need for urgent ‘credit’ and you would have done your calculations based on the profits to be made once the business gets going, that will pay-off your instalments in the future.

Financial Institutes

There is money to be made from loans and all financial institutes will lend money on their own terms so that they can recover a larger sum over a period of time (tenure if the contract). Although they may permit small sums without a collateral (personal loans), many a time the borrower would want a bigger loan (to purchase a house) and that attracts a huge interest on top of the principal sum borrowed. In fact the longer the loan the larger the total repayment is. By keeping the duration of repayment short and taking a smaller loan would be preferred. Again look up the numerous ‘mortgage’ calculators for the instalments to be paid against the duration (years) and the interest rates.

There are quite a few financial institutes willing to give loans to eligible borrowers. Apart from commercial banks, the Finance Ministry gives loans to government servants at reasonable rates (4%). Insurance companies, cooperative societies and private agencies also provide this facility. But avoid the ‘loan sharks’ introduced by friends or through advertisements you would find on telephone post and walls of buildings. Another mode is the use of the credit card for emergency funds and daily transactions. Much has been written about the use of credit cards to draw funds. Be mindful of the huge interest (15-18%).

Interest Rates

Having said that let me reflect on the first housing loan I took from a commercial bank in the 1980’s. It was difficult as the bank manager was cautious of approving my request as times were hard and my income was meagre. However, it was for a small house and hence that was used as the collateral. Though I had come out with a 30% down payment, it did not matter as far as the interest rate was concerned, it was 11.8%! There were no further negotiations, nothing to discuss about monthly rest or yearly rest. Of course the former would be advantageous to the borrower.

Currently the mortgage on houses and property at large draws lower interest and figures like 6-7 % (above the base lending rate) are not uncommon (check with the respective institutes for accuracy).

There are several schemes of repayment that may reduce the total sum borrowed and that is good.

Reducing your borrowings legally

A recent article in the NST (Jan 27, 2012) entitled ‘Turning debt into wealth’ by Michael Yeow, is worth sharing. He zooms down to some fundamental principles. I chose this subject as by far taking a housing loan is by far one of the largest financial commitment and many say that about 30% of our earnings go to paying off the housing loan. Basically you tend to pay about RM 500 000 when you compete repayment of a loan of say RM 250 000 after 30 years. You would not appreciate this till you did the ‘numbers’. On the other hand that would be the only way you would be able to purchase a property. Using the current rates, Yeow says that when you take a 30 year loan you would have reduce not more than 7 % of the sum at the end of five years! Now that is truly depressing. Now what will it be after say, 20 years; you still have to pay another 50 % of the principal sum.

The article highlights ways and means to reduce the loan if possible rather than wait till the tenure ends. Again it is advisable to shop for the loan that best fits you and your earning income. Be aware that the financial institutes would not be happy if you settled your loan within a short period (say by 3 years because you had a windfall, or a relative left you a huge sum in his will!) after signing the contract say for 15 years. A penalty is imposed on such repayments.

Yeoh highlights the following strategies to reduce you loan amount:

·         Paying more than the stipulated instalment

·         Fortnightly payment rather than monthly payment

·         Refinancing

·         Using Flexi Mortgage

·         BLR adjustment

·         Drawing savings from the Employees Provident Fund

Paying extra each month to reduce the principal sum borrowed would reduce the total sum to be repaid but requires negotiation with the bank and how the contract is written. A word of advice is to ensure that the extra sum really is utilized to reduce the principal loan amount and is not used to contribute to payment of the instalments (which includes the interest due).

Fortnightly payment is preferred, if you can afford this as you would be reducing the total due. More instalments and less to repay. Yeoh says that by a simple arrangement like paying twice a month you would effectively reduce the 30 year tenure by four years!

Refinancing would incur the formalities of re-drawing the contract, processing fees and legal fees. But one needs to do his calculations to see if this is worth it. Well if the interest I paid (11%0 has dropped to say 6%. Clearly it is worthwhile re-financing. So keep tract of the base lending rate and what interest is being charged currently when you have drawn a contract for 30 years. The financial climate out there is changing f very rapidly and interest rates have fallen considerably over the last few years. Another option the author mentions is to maintain the same instalment but request the bank to reduce the interest rates. It is worth talking to the bank officers as they too want to maintain a good relation with clients and are amenable to negotiation. The financial institute would want you to be regular with your payments and any default will impact on their business as’ 'non-performing loan’

The Flexi Mortgage has become popular with many as it involves having a current (mortgage account) where you can deposit all the extra money you have without any negotiations. As long as there is adequate funds that do exceed the sum promised as instalments, no interest is drawn. Another feature is that interest is on daily rest and not a monthly rest. That arrangement is advantageous to the borrower. So keep the instalment on schedule, deposit any extra cash you have and get the principal sum reduced.

It is always important to watch the base lending rate (BLR). The BLR is regulated by the National Bank and interest is based on this figure (BLR +4%). So if the BLR is 3%, the interest would be 3+4=7%. The BLR will fluctuate and hence one needs to talk to the bank as to how it affects your instalment. In most instances the bank would send you a note of changes in the BLR and how the interest would be affected. This means that it will also affect the instalment. If there is no change made to your instalment in spite of a higher BLR, then you may be paying for a longer period! Best advice is to pay the extra sum when the BLR rises.

The EPF has an account (II) which you could withdraw to reduce the principal sum and effectively reduce the repayment period. But be mindful of any penalties that may be incurred with early payment. Discuss with the financial institute as to how it will be advantageous to you.

Conclusion

I was happy that Michael Yeoh has summarised the measures you should take when borrowing money from a financial institute to purchase a property. Read the contract and see how you could repay in a shorter period so as to save your money.

Siva

29 Jan 2012

Caveat:  The contents of this article are not written by an expert in finance. Kindly check for accuracy with your financial adviser.