Today's uncertain economic outlook calls for consumers to think about what they actually need to spend to maintain the lifestyle they are accustomed to and carefully assess if they have the financial flexibility to cope with changes in circumstances.
Although consumers may start thinking about spending on big ticket items like holidays, home renovations and car purchases to take advantage of the relative strength of the Indonesian rupiah, before prices increase further due to inflation, consumers should still exercise prudence in their spending.
Consumers should evaluate carefully if they really need to take a loan, as debt can be a complex issue. It is therefore necessary for consumers to be able to differentiate between "good" and "bad" debt.
What is good debt - It essentially helps one make purchases for items or essentials one may not have enough savings for at the moment, but can well afford in the long run. It is essentially debt that can create value. When used intelligently, debt can be positive and even be of assistance in building wealth.
Examples of "good" debt can broadly be divided into four areas. These include: credit card purchase of basic necessities such as groceries, loans taken to purchase assets such as property that may appreciate in value.
Other areas include activities or items that are beneficial such as education, to enhance one's qualifications, that will likely increase one's earning ability and long term returns. The last one is loans for business ventures for which business owners need cash that they do not have at the moment, to fund or expand their facilities.
In addition, debt, if used prudently, can be leveraged to one's advantage in certain circumstances. For example, one of the most common uses of loans applies to the purchase of cars. We all acknowledge cars are often regarded as depreciating assets, and fail to realize the value we get from the car when it helps us get to work to earn a living.
"While some consumers may be able to pay for their cars upfront with existing cash without taking a loan, most will prefer to leverage debt so that they can free up cash for other purposes that may yield greater benefits, in their opinion.
Depending on the individual's unique circumstances, the "freed-up" cash can be used as emergency reserves to prepare for a rainy day. Or, it may be used by savvy investors who can generate returns in excess of the interest rate they pay on their auto loans. There are also some small business owners who find it cheaper to take a car loan, and use their available cash to finance their business needs, and hence gain better returns.
For instance, take a car loan for US$100,000 with an effective loan interest rate of about 5 percent per annum. A business owner who can afford to pay cash for the car, might take full financing at these rates and use the cash to finance his business needs instead, considering that current business loans have an interest rate around 10 percent per annum, effectively leveraging debt to his advantage.
Meanwhile, a debt is considered "bad" when a person has to stretch himself beyond his means, overspends as a result, and is unable to settle his loan repayments. As a general rule of thumb, most financial experts recommend that an individual's total personal debt should not exceed 36 percent of his/her gross income. Besides the debt-income ratio, keep in mind that a person can fall into a debt trap through the accumulation of late payments and interest charges as well.
For example, the concept of "bad" debt often comes into play when discussing the purchase of discretionary items using high-interest credit cards and not having the ability to pay off the credit card bill in full. The discretionary items, especially if purchased without considering one's financial situation, continues to lose value, while the amount one paid for it continues to increase.
Exacerbating the "bad" debt factor, some consumers may be tempted into applying for in-store credit cards for the savings offers that range from 10 percent to 20 percent off the cost of purchases upon signing up immediately.
What people often do not realize is how much of that saving may be lost by the high interest rate, sometimes as high as 24 percent per annum, on the card if they fail to pay for these items immediately. Penalty charges for late credit card payment can also be incurred and amount to additional expenses on top of the higher interest rates.
Be careful to avoid turning "good" debt into "bad" debt by considering factors such as other existing monthly payment obligations, both fixed (e.g. housing, car, insurance) and variable (e.g. food, clothing) as well as possible shifts in the economic climate, to ensure that you are comfortable with the monthly repayments and prevent unnecessary late payment charges.
Of course, even after careful planning there may be instances when consumers need to make adjustments to their cash flow, or would require a loan. Consumers should then look for personal loans in the market that gives them repayment flexibility in case they are not able to meet repayment deadlines for any reason.
For example, flexible repayment options can include payment holidays, the option to pay interest only at the start of the loan, etc. These features help individuals manage changing financial circumstances, by allowing customers to allocate cash to where it is needed most, without incurring heavy penalties for taking a break from the loan payment. Ultimately, a loan can help an individual, and can be a positive affair when taken responsibly.
The writer is CEO of GE Money Indonesia. The above article is his personal view. He can be reached at zackykhumam@gmail.com
