How do banks make money? First, they collect money from you in the form of savings and current accounts, fixed deposits, and other types of deposits. It is a debt by the bank to you. As such, they pay (a small) interest to you.
Banks are licensed to lend money to borrowers especially to purchase properties, cars, goods, merchandise and to go for holidays, for which they charge a much higher interest rate.
The difference between the two (interest income and interest expense) is huge. Public Bank Bhd reaped a RM7.6 billion profit in 2018 from the margin between the two, the highest in the 50 years since its founding.
This business is so lucrative that banks make billions of ringgit in profit each year. Public Bank made a net profit of RM4.55 billion in 2018 just from their banking operation.
Now let’s introduce the concept of the third group of people. They stand on both sides, as borrowers and lenders, just like the banks.
You need to be a smart money user and a sophisticated investor to benefit from this relationship. Most people are both lenders and borrowers.
The rich earn more interest income than pay interest expense and thus, receive net interest income.
The rest pay more interest expense than earn interest income and thus, spend possible net interest expenses.
Question 1: Should I cash out my EPF to pay off my mortgage?
If you are considering this you are possibly looking to be debt-free. At a glance, it looks like a good financial move.
However it is not a smart move as you are forgoing six+% in EPF dividends to save four+% in interest expenses. Hence this is a classic example of how being debt-free is not wise.
Question 2: Should I cash out my property to pay off my credit card debt?
The answer here is yes. If you have outstanding credit card debt that is a substantial figure, you are paying 18% interest on it.
Therefore it is best to get a mortgage (refinance your property) at four+% per year to pay off your outstanding credit card debt.
Question 3: Should you borrow to invest in the stock market?
For most, the answer is no because most people are trying to make a quick buck from “capital appreciation”, which is not guaranteed.
Most people tend to fail as they do not know what they are doing in the stock market. The catch is that your interest payments to the bank are fixed.
If you lose your principal sum of money, how are you going to pay your borrowings back to the bank?
Question 4: Should you obtain a short-term loan to run your business?
This depends on whether it is worthwhile doing so. For instance, if you have secured an order from a client for a product at a fixed price, you can proceed to obtain a loan and use the money to manufacture and deliver your product to your client.
If your profit margin exceeds the interest costs from your loan, you should go for it.
Question 5: Should you take a mortgage to flip properties?
Property flipping is a method to profit from properties, but currently it may not be the best time to do so.
However, if you insist, do prepare reserve funds to service your mortgages if you fail to flip your properties and flop instead.
Remember the rich pay interest to earn interest. Most of them do not pay interest to gain capital appreciation.
Conclusion
The rich, like Tan Sri Teh Hong Piow, Founder and former Chairman of Public Bank Bhd know about debt and have profited to the tune of billions from this knowledge. The rich, for the most part, do not have plans to be debt-free.
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.