Many people are advocates of being debt-free. They opine that being debt-free releases them from paying interest costs. That opinion is excellent if you wish to remain in the middle-class.
But if you have a sincere desire to be well-off, you need to think about debt and your relationship with it.
If you are new to finance management, start with the basics. There are two parties in a loan agreement: the lender and the borrower.
The lender lends money to the borrower and is compensated with interest income for he has temporarily given up his right to use his own money to the borrower.
The borrower receives money from the lender and has the choice to use it as he deems fit. To enjoy that choice, he has to compensate the lender with interest.
Below is an example of a lender and a borrower:
Are you a borrower or a lender?
If you want to make more money, let your assets work hard for you and generate passive income non-stop. Anyone with a sound mind will choose to be a lender. You want to be the one with loads of cash, lend it out and make tons of money.
The easiest way to be a lender is to deposit your cash in a fixed deposit option offered by the banks. You immediately earn some interest from the very first day.
But before you jump to this conclusion, please examine the illustration above again. Do you notice an anomaly?
Take a minute to look closely at the list of lenders and borrowers. Do you see any repeats? You’ve probably noticed that some people are listed on both sides.
The most obvious example are the banks. They are the mortgage providers, and they also owe money to their depositors.
Another example are P2P financing investors. They are most likely credit card users too.
If you have a mortgage or use a credit card, and you also have an FD, you are on both sides too. A landlord is also a borrower if he still servicing his housing loan instalments.
You have to pay interest to earn interest.
Back to the question – are you a lender or a borrower?
You may wish to be solely in the lender category. You want to be loaded with money to lend out for interest income. On the flip side, you do not want to be in the borrower category as you may find it depressing to keep on paying interest to the lender.
Of course, you can be both a lender and a borrower.
If you have invested in a portfolio of real estate, you are a landlord who collects rental income (interest) from your tenants. At the same time, you are a borrower as you have to service the mortgage (pay interest costs) on your properties to your bankers.
This is the concept of paying interest to earn interest. Obviously, you make the difference or margin between the two, but who do you think is the best in this business of paying interest to earn interest? The bankers.
Below is a screenshot from Public Bank Bhd’s annual report 2018. Two things are highlighted:
1. Loans, advances and financing. These are assets to the bank for they represent the amount Public Bank Bhd lends out to its borrowers and earns interest from.
2. Deposits from customers: These are liabilities to the bank for they are monies deposited (loaned) by depositors to collect interest payments.
The above ratio of 30:30:40 is ideal for people who make less than RM10,000 in monthly income. It is okay for you to use debt to invest, raising your DSR to a higher level if you make in excess of RM10,000 per month.
Do keep an eye out for part two of this article which will be out soon.
This article first appeared in kclau.com
KC Lau’s first book Top Money Tips for Malaysians has sold thousands of copies. He launched the first online personal finance course specifically designed for Malaysians, entitled the Money Automation System. He also co-founded many other online financial courses including the Bursa Method, Property Method, Founder Method and REIT Method.