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Agensi Kaunseling dan Pengurusan Kredit (AKPK) Level 8, Maju Junction Mall 1001, Jalan Sultan Ismail 50250 Kuala Lumpur Fax: 03-2616 7601 E-mail: enquiry@akpk.org.my AKPK Second Edition 2013 The copyright of this book belongs to Agensi Kaunseling dan Pengurusan Kredit (AKPK). This book or parts thereof, may be reproduced, translated, or transmitted in any form with prior written permission from AKPK only for the sole purpose of education. No monetary gain in any form should be made or derived, whether direct or indirect from such reproduction. ISBN 978-983-44004-2-2 Disclaimer: The information contained in this book is solely for educational purpose. It is not intended as a substitute for any advice you may receive from a professional financial advisor. AKPK disclaims all and any liability to any person using the information in this book as a basis for making any financial decision or taking an action. While all efforts have been made to make the information contained in this book accurate, AKPK seeks your understanding for any errors or omission. The names and details of individuals in the real life cases have been changed to protect their identities. Book 1.indb 2 3/25/11 11:40:53 AM
ep ro du ce d R N ot To Be CHAPTER Book 1.indb 23 2 BORROWING BASICS 3/25/11 11:41:10 AM
Credit and debt To borrow or not to borrow, that is the question! With numerous loans and credit cards offered by credit providers in the market today, you may be tempted to spend more money than you actually have through borrowings. Borrowing from credit providers allows you to obtain money on loan or get a line of credit to enable you to buy a house, a car, pay your bills or even go on holidays. Although a loan is beneficial, particularly in helping you pay for big purchases, it is crucial for you to keep in mind that the money you borrow is not free. Money on loan needs to be paid back with interest and penalty charges when it is repaid late! Credit is a facility to borrow with an agreement to repay the creditor, as per the terms and conditions outlined in the contract. 24 Book 1.indb 24 3/25/11 11:41:10 AM
You are given a credit card with a limit of RM3,000. If you have spent RM1,000 on your credit card, that RM1,000 of utilised credit now becomes a debt. BEFORE AFTER DEBT : RM3,000 credit available : RM2,000 credit still available : RM1,000 WHY DO YOU BORROW? When you borrow, you need to ask yourself what is the purpose of your loan? Keep in mind that you should only borrow to meet your needs and not your wants. When you want to take a loan or use a credit card to purchase something, ask yourself the following questions: Is the product or service I intend to purchase a need or a want? Can I afford to pay the instalments? If it is a substantial purchase, such as a car or a house, can I pay a larger down payment? 25 Book 1.indb 25 3/25/11 11:41:13 AM
It also helps to know the basics of borrowing. Rules of borrowing Borrow for productive purposes only and for something that you really need but do not have enough cash to pay for. This includes buying a house or a car, sending your children for further education or meeting emergency needs. Borrow within your means. You should only borrow an amount that you can pay back comfortably. It is recommended that your total monthly repayments should not exceed 40% of your net monthly income (after statutory deductions i.e. tax, EPF and SOCSO). A borrower has a moral obligation to repay as there should be no excuses for not repaying your debts. Always bear in mind that your creditworthiness will be affected if you do not repay your loans according to the terms of repayment. Here are some examples of productive debts versus unproductive debts: PRODUCTIVE DEBT (Buying appreciating assets) Money borrowed at competitive rates to invest in quality assets UNPRODUCTIVE DEBT (Funding lifestyle) Taking a new loan to pay an existing loan without any cost saving A housing loan that is being A high interest personal loan paid off in a planned manner to pay for holidays or other lifestyle costs As highlighted in the table above, borrowing for the right reasons can help enhance your overall net worth. Now that you know why and when you should borrow, let us look at the sources of borrowing. 26 Book 1.indb 26 3/25/11 11:41:13 AM
COMMON SOURCES OF BORROWING There are various credit providers in Malaysia. The following are common sources of borrowing: Licensed Financial Institution (LFI) LFIs, including commercial banks that are licensed by Bank Negara Malaysia (BNM), provide credit facilities to the public. You are strongly advised to borrow from a LFI as there are rules and regulations in place to safeguard your rights. Browse the website of BNM www.bnm.gov.my for a complete listing of LFIs Co-operative Co-operatives are regulated by the Ministry of Domestic Trade, Co-operatives and Consumerism (MDTCC). Members of the co-operatives may borrow from their co-operatives based on their eligibility and other criteria set by their management. Licensed Money Lender (LML) LMLs are lenders licensed by the Ministry of Urban Wellbeing, Housing and Local Government to provide loans to the public. However, unlike LFIs, they cannot accept deposits and their interest rates are normally higher than LFIs. So, it is advisable that you always check the rates offered by these LMLs before taking a loan. Unlicensed Money Lender (UML) UMLs are illegal and commonly referred to as Loan Sharks or Ah Longs. You should never borrow from UMLs. UMLs offer unsecured loans at very high interest rates with vague but strict terms and conditions. These UMLs resort to threats and violence on borrowers who cannot repay their loans. 27 Book 1.indb 27 3/25/11 11:41:13 AM
TYPES OF LOANS Secured loans Backed by assets and normally easier to obtain In the event of default, the lender will be able to take possession of that asset and sell it to recover the loan Examples of secured loans are housing loan and car loan Unsecured loans Not backed by any assets Rely on your ability to repay the loan and your credit background Generally smaller in amount, shorter in tenure and have higher interest rates In order to mitigate the high risk, sometimes require a loan guarantor Examples of unsecured loans are credit card and personal loan 28 Book 1.indb 28 3/25/11 11:41:13 AM
ep ro du ce d ISLAMIC BANKING R Islamic banking institutions are licensed by BNM and follow Syariah (Islamic principles), which prohibits riba (collection and payment of interest), usury (the act or practice of lending money at an exorbitant interest rates), trading in financial risk and haram (unlawful) business ventures. Be In Malaysia, we have the opportunity to choose between conventional and Islamic banking, which is for all individuals regardless of their religious beliefs. N ot To Islamic banking operates according to Syariah rules on transactions, known as Fiqh al-muamalat. The basic principles of Islamic banking are the sharing of profit and loss as well as the prohibition of riba. Some common concepts used in Islamic banking include profit-sharing (Mudharabah), safekeeping (Wadiah), joint-venture (Musharakah), cost-plus (Murabahah) and leasing (Ijarah). Islamic banking products in Malaysia are monitored by the Syariah Advisory Council set up by BNM in addition to each Islamic bank s own internal Syariah review committee. 29 Book 1.indb 29 3/25/11 11:41:15 AM
WHAT DO LENDERS LOOK AT? When you apply for a credit card, a personal loan, or any other type of credit, the lender must first evaluate if you are a good credit risk. When assessing credit risks, a lender looks at the ability of a borrower to meet loan obligations which will, to some extent, determine the pricing of the loan. The success of your loan application largely depends on the following: The 3Ps of credit 1Purpose 2 of borrowing Payment ability Lenders want to know why you are borrowing to assess the risks involved. The type of loan is then matched to your purpose for borrowing. If you are buying a house, then it is a housing loan while a hire purchase loan would be given to finance a car. The purpose and whether the loan is secured or unsecured will, among others, determine the interest rate and tenure of the loan Your repayment capacity is vital. Lenders are keen to see enough surplus income or cash reserve to meet your new financial commitment. They would like to be assured of your stable income or continuity of employment. Here, your cash flow position is evaluated. An important indicator of your payment ability is your debt-to-income ratio 30 Book 1.indb 30 3/25/11 11:41:15 AM
3Payment history Your past track record on repayments of your earlier or existing loans are looked at to determine what type of paymaster you are. If your repayment records are not satisfactory, your chances of getting a new loan may be slim DEBT-TO-INCOME RATIO A debt-to-income ratio indicates a person s total monthly loan repayments against his net monthly income. A high ratio indicates that a person may not have enough cash for his monthly needs. As a general rule, your total monthly repayment on all your loans and credit card debts should not be more than 40% of your net monthly income Encik Daud s net monthly income is RM3,800. His total monthly loan repayment - housing, car and credit cards are RM2,128. Debt-to-income ratio = Monthly loan repayments Net monthly income = RM 2,128 X 100% RM 3,800 = 56% 31 Book 1.indb 31 3/25/11 11:41:17 AM
As you can see, Encik Daud s debt-to-income ratio is higher than the recommended amount. In this scenario, it is best that he strives to bring down the ratio. So how do you bring down your debt-to-income ratio? You can either increase your income and/or lower your loan commitments. It is important not to over commit on loans and purchases using credit cards as this would have an impact on your ratio and in turn, may affect your creditworthiness. BEING A GUARANTOR When an individual s creditworthiness is doubtful, lenders would normally request for a loan guarantor. A guarantor is not the principal borrower. However, a guarantor is still responsible for the unpaid portion of the loan, including interest, if the principal borrower defaults. The guarantee for the borrower s obligation will last until the full settlement of the loan. A guarantor cannot be discharged without the full settlement of the loan or prior to obtaining the lender s consent. 32 Book 1.indb 32 3/25/11 11:41:17 AM
Guarantor s liability Age : 28 years old Occupation : Engineer Marital status : Single Sam and Ling were in a relationship. They met when they were both students at a local college. After dating for a couple of years, Ling asked Sam to become the guarantor for her hire purchase (HP) loan. Sam agreed to the request immediately and signed the guarantee without hesitation. As Sam decided to be the guarantor for Ling s HP loan out of love and affection, he did not seek advice from anyone before signing the guarantee. In addition, Sam was also confident that Ling would repay the HP loan on schedule and that they would be married soon. Three months after taking the loan, Ling started defaulting on her HP loan repayments. Sam helped Ling to pay for her arrears until he found out that Ling was engaged to be married to another man. Shocked and broken hearted upon discovering Ling s engagement, he broke contact with her, changed jobs and moved to a different state. Unknown to Sam, Ling continued to default on her HP repayment and changed jobs and homes frequently. As Ling did not service her loan, the lender repossessed and auctioned her car. After the sale, there was still a shortfall of RM45,000 owing to the lender. As Ling could not pay the shortfall from the auction, the lender demanded the shortfall from Sam instead as he was the guarantor for the loan. However, even for Sam, the shortfall amount was too big to pay off. Due to his inability to cover the shortfall, the lender initiated legal proceedings against Sam to recover the outstanding balance. Worried about his financial predicament, Sam sought AKPK s advice. 33 Book 1.indb 33 3/25/11 11:41:17 AM
EFFECTS OF INTEREST RATE Interest is cost paid for the use of borrowed money or money earned on deposited funds. The interest rate charged on loans is a measure of the risk that the lender takes in funding the borrower the greater the perceived risk, the higher the interest rate. Generally, there are three types of interest rates quoted in the market. They are: Flat Rate Fixed Rate Floating Rate Interest calculated upfront on the amount of money borrowed over the entire loan tenure Interest calculated based on a reducing balance basis, whereby the interest rate does not fluctuate during the loan tenure Interest calculated based on a reducing balance basis, whereby the interest rate is tied to an index or base rate and fluctuates over the period of the loan. The most common index or base rate used is the Base Lending Rate (BLR). If the term BLR is no longer used, it will then follow the rate of interest applied by the lender. Flat rate is generally more expensive as it is calculated upfront on the loan amount over the entire loan tenure. This differs from fixed and floating rates, which are calculated on a reducing balance basis. 34 Book 1.indb 34 3/25/11 11:41:17 AM
Understanding compound interest Compound interest is just like a series of simple interests, where the interest incurred is added to the original principal, which is then included as principal for the next period. Compounding can be done annually, monthly or daily the more frequent the compounding, the larger the interest effect. Compound interest, thus, can be a double-edged sword while it helps to give more return on investments, it also results in more interest being charged if there is a delay in repaying a loan or credit card debt. A common application of such method is in the computation of a credit card debt, which we will be covering in Chapter 3, and also a housing loan interest computation in Chapter 5. Bank Negara Malaysia s (BNM) guidelines on product transparency and disclosure Recognising the importance of adequate and effective disclosure to consumers, BNM s Guidelines on Product Transparency and Disclosure serve to raise the disclosure standards for retail financial products and aim to support informed consumer decision-making through meaningful and timely disclosures. You are advised to request and understand the product features before deciding to accept any loan facility. 35 Book 1.indb 35 3/25/11 11:41:17 AM
takeaways Borrow to meet your needs and not your wants; borrow for productive purposes only Borrow within your means try to keep to a debt-to-income ratio of not more than 40% of your net income When you borrow, keep the 3Ps in mind: - Purpose of the loan - Payment ability (repayment capacity) - Payment history (track record) Understand the different types of interest computations and its effect on your total borrowing costs Think carefully before agreeing to become a guarantor because if the borrower cannot or refuses to pay, you are liable! 36 Book 1.indb 36 3/25/11 11:41:18 AM
Checklist Do you know your total cost of borrowings? Calculate your current debt-to-income ratio. Is it below 40% of your net income? Do you know the due dates of all your loan instalments? Are you a guarantor for any loan? If yes, is the borrower paying on schedule? 37 Book 1.indb 37 3/25/11 11:41:19 AM
Do You N ot To Be R ep ro du ce d Know 38 Book 1.indb 38 3/25/11 11:41:20 AM
SELF ASSESSMENT 1. Interest rates for unsecured loans tend to be a. lower b. higher c. constant d. flexible 2. The following are credit assessment criteria used by credit providers when evaluating a loan application: a. Payment ability b. Payment history c. Purpose of borrowing d. All of the above 3. Your debt-to-income ratio should NOT be more than a. 40% of your gross monthly income b. 40% of your expenses c. 40% of your net monthly income d. 40% of your debt 4. If you are a guarantor, the bank can a. ask your friends (not guarantors) to pay the outstanding amount b. seek repayment of the loan from family members (not guarantors) c. ask you to repay other loans owed to the bank not guaranteed by you d. ask you to pay the outstanding amount if the borrower fails to pay 39 Book 1.indb 39 3/25/11 11:41:20 AM
5. Which of the following statement(s) explains compound interest? a. Interest incurred and added to the original principal which is included as principal for the next period b. Interest is charged on the principal loan only c. Interest is charged on the unpaid interest portion only d. None of the above 6. Which of the following is true with regards to Islamic Banking? a. Licensed by Bank Negara Malaysia b. Follows Shariah (Islamic principles) c. Sharing of profit and loss d. All of the above Check your answers at the end of this book 40 Book 1.indb 40 3/25/11 11:41:20 AM