A reader (27 year old network engineer) wrote in to me asking me if I can advice him regarding some wealth building queries but also surrounding some advice on steps to take to help out a family debt situation. The topic is challenging in a few ways. I felt that asking me is probably not the right person to ask since I didn’t have first hand experience in clearing an astronomical large loan amount ( I have a feeling the actual family loan is larger than the title figure).
In my life I had 2 loans, a $15,000 student loan from my parents and taking over what was a $50,000 housing mortgage which I paid in cash. I guess a sum that will put me down could possibly be $100,000 when I started working at age 24, but guess that didn’t happen.
I doubt its my practice to give step by step instructions but perhaps go through the thought process how I look at things like this and my reader’s situation.
Getting the figures right
Being more tilted to the technical side, I usually want to know the facts and figures that needs to make decisions. Like most project schedule, cost when given time, it is better to get the closes figures and work bottom up to come up with an accurate figure to reduce your risk.
In the case of doing debt payment evaluation, the most fundamental are how much I would need to pay per month, per year, how much total interest that I need to pay. It is also important to figure out how the debt works, whether there are opportunities to refinance, pay off early without penalties.
Having these information allows me to compare against other comparable in terms of pay off or opportunity cost
Decide on how much emotionally or my determination to clear the debt
Your relationship with debt is not always about dollars and sense, reaping rewards or not losing out. It is how you are comfortable with it.
I have friends who absolutely cannot stand it, perhaps haunted by events in the past, thus they would always want to channel more to paying debt off.
Then there are some who believes that they can control this ‘monster’ and would give it a try (since almost everyone is doing it)
The ownership of the debt will also affect your commitment towards it. In the case of my reader, it might be the case that the ownership of the debt does not belong to him and thus it is seen as a burden more than the reward or utility he is enjoying.
I know that is how I look at the 2 debt differently. I felt I have more of an obligation to pay off the student loan debt compare to the housing loan since I wasn’t so keen to move then, in the first place.
The last aspect is the priority you value things. This differs from person to person. For a person that cannot stand debt or that the interest is crazy high, the person is likely to prioritize debt pay off high. Yet for my reader it seems he does see building up wealth as perhaps an equal priority to his commitment to pay off debt.
Calculating and comparing various scenarios
In general, there are certain rule of thumbs if we talk dollar and cents.
If the debt involves very high interest rate, clear it fast. Try to prioritize it.
If you have no idea how to build wealth (fixed deposits, endowments, stocks and shares, property, business) better than the interest paid, it is better to pay off debt as fast as you can.
If you have some idea how to do that, first make sure that your idea is fundamentally sound. Do evaluate with someone that is more knowledgeable in this area so that you don’t come up with some wrong conclusion.
You can calculation the projection of the interest paid over duration versus the returns of the alternative, which may be perhaps investing in a cafe business or put in Starhub stock which yields 4.7%. (refer to Dividend Stock Tracker here)
You will also need to evaluate your ability to build wealth wisely over the same period, some people come up with some crazy idea that after I read some investment books its better I delay debt payment since i can make 12% per year versus a 5% student loan, after which, it turns out their performance is not quite there.
Alternatives and Contingencies
If you have a degree of confidence in your own abilities, also build in some safety net:
- Do you have an emergency fund of 3-6 months expenses
- In the event that your performance are not up to scratch, can you access part of your wealth funds to pay off more of your loans
- In the event of need, how liquid is the family and sources of quick credit (its not the most advisable to borrow from others, but going through this thought process reduces the stress level when the actual situation hits)
How much to pay off?
The amount of monthly repayments from take home income are usually balance between the fastest repayment versus risk management. You don’t want to pay off so much that, you do not have flexibility in case there are some contingency cash flow required.
At the same time you don’t want to pay off so little that you chalked up a bunch of interest, takes forever to pay off and just make you feel miserable.
For exploration come up with a few actual repayment scenarios.
In the case of my reader, he has some priorities to building wealth, as well as repaying debt not to mention the expenses that he cannot escape. What he can do is work out different % of each scenario:
- The extremely fast repayment
- 1 or 2 comfortable pace repayment
The objective of the exercise is that, through looking at the figures, it gives him or her the idea what kind of lifestyle that he will go through with for the next X years. We each have a different level of tolerance due to our outlook of life. The extreme scenario is for the ones that have very high discipline, and would like to treat this debt pay off project as a challenge.
Ability to do an extreme repayment
Whether you can successfully go through paying a high amount would depend on character, a person’s perception of himself or herself, of his working counterparts, his friends and family, his world. This is because even if he is willing to go through with it there will be much push back. Your friends will look at you strange for not going out with them. Your working network will be affected because you failed to participate actively during lunch and after work activity.
Which is why my thought is that you can do this for some extremely high interest loan that you cannot drag too long else financially it is detrimental or that the duration of repayment is short.
I am not sure if the total loan is $30,000 or $60,000, or the amount he earns as a network engineer. A network engineer that earns $3,000 per month for 14 months would earn $42,000.
Can he realistically pay off $30,000 in 1.5 years, not saving or spending extravagantly? I think its possible.
After CPF, he would take home $48,000. He can pay off $30,000 and still have $750 per month.
$750 per month looks very little but lets take a step back. Some graduates have a $28,000 student loan to pay off. Its not so different from my reader here.
Now how much does it take for a graduate to survive BEFORE he or she graduates?
A student probably have the follow:
- Transport: $120
- Eating out: $200
- Entertainment: $160
- Materials: $100
I survived university on $250 per month but I had a torrid time due to not taking pocket money and doing part time. I think this parameter is comfortable (students please tell me if my figures are off)
Now, extreme repayment of debt is more of an extension of your university life by 1.5 years. You won’t be like someone like me, 35 years old, who have already been ‘tainted’ by much extravagance due to earning a better allowance then during university days.
We are not asking you to live like that forever. Just 1.5 years more. Then you start off with a clean slate.
This is the extreme case.
If you want some slack, delay for 2 months. You have $240 per month more to work with. That is an obscene amount of money for a student mindset.
Build up a $6,000 Emergency Fund First or Concurrently
If I were in his position, I would try to build up an amount for contingency (read my comprehensive emergency fund guide here) concurrently.
Perhaps he or she has to delay the debt repayment by 2 months (the $240 per month previously mentioned will build up $4,800)
The reason is that you don’t want to turn to additional high interest debt such as cash line because you pay off aggressively. You also don’t want to spend what is left over such that you do not have any slack.
If your family had an emergency, you can turn to this amount.
Manage your own satisfaction and happiness during this period
The reason of clearing debt are usually not happy. Unless you get into debt for a life goal like home dwelling or graduate studies. In other cases you made a mistake, or that you need to have a vested interest in other people’s mistakes.
Its difficult to articulate but you got to reach deep and come to terms a reason for being responsible and discipline to clearing the debt. Be it that your dad gave you more opportunities and brought you up more than the mistakes he made, or that visualizing the short term challenges to wipe a clean slate and never have to relive this mistake again.
Often one of the most important advice is that, learn to be happy with less. It will help you live past this period.
One of the hotel managers I been to told me that many of the problems resulted and the solution can be resolved by communicating better. In this case how people look at you depend a lot on the story you tell them. If you tell the story with really pathetic body language and poor work ethic people will pity you for doing things so drastic.
If you explain well your well thought out plan, it might make them look at you in a different light, perhaps gain some respect.
Sunday 8th of March 2015
Your example reminds me of a time in life where I was living a $20 per day lifestyle in trying to build up my emergency fund. My advice to the reader is to manage the debt based not only on his own financials but also on his lifestyle.
Sunday 8th of March 2015
hi Derek, very right. one seldom unobserved good thing about debt is that you work within a tight parameter (but many didn't realize this skill of yours if we didn't articulate out to them)
Sunday 8th of March 2015
Are we the type of person who keep thinking and sometime worry about our housing loan and sometime worry about getting retrenched?
If yes, we are better off to clear our housing loan asap and cease this worry.
I am one of these type of person so I cleared my housing loan asap and create an environment that my wife could become stay-at-home mum and we can survive on single household income.
Sunday 8th of March 2015
that is a life decision goal that you have to factor in. its got nothing to do with quantifiable values anymore. stay at home mom is something alot of ladies want but reluctant to forgo their current lifestyle just to be a better one