It’s easy to put more focus on your portfolio and asset while forgetting the liability side of your balance sheet. But at the end of the day, your personal net worth has two sides; asset on one side and liability on the other. Therefore, if you normally shun the liability side of things, think again.
How to manage your debts wisely
Start by figuring out what the overall debt level is appropriate for your needs. Usually, this can be done by using the 28/36 industry rule.
The first part means no more than 28% of pre-tax household income should be allocated to servicing home debts. This should include all home-related loans, their interests, principal payments, taxes, and insurance.
The second part means that you should not dedicate more than 36% of your pre-tax income to payment of all debts. This includes personal loans, credit card debts, auto loans, and so on. Let’s break it down further using the guideline below:
- Anything below 30% is great
- 30-36% is fine
- 40% is considered borderline
- If it’s above 40%, you’re walking in dangerous grounds especially if the debts have varying interest rates
How to determine whether or not a personal loan/business loan is appropriate for you
You should be concerned with how much you’re going to pay to take a specific loan. Secondly, you should be aware of how you’re going to spend it. Thirdly, you need to determine if the repayments are manageable.
Once you’ve assumed an overall level of debt that you think is appropriate for you (based on your income and needs), start thinking of ways to minimize your debt payments. Unsecured installment loans and credit cards are the most expensive of loans. These loans typically have double-digit interest rates and are generally not tax-deductible.
However, the good thing is that if you live in Singapore, you still have 3 main sources of low-cost loans whose interest rates are tax-deductible if you qualify.
Mortgage or home equity loans
Mortgage loans are one of the most attractive loans in the Singapore market. All mortgage debts up to $1 million are tax-deductible, whether this relates to your primary or secondary residence. Also, if you have up to $100k home equity loan, it will qualify under the category of tax-deductible loans. However, before you make a move here, always consult with a financial advisor to ensure you’re not subject to the alternative minimum tax or AMT.
You will pay interest on money borrowed to finance taxable investments. It’s not the source of the funds that matter. Rather, it’s the purpose for which you’re borrowing these funds that will earn you tax deductions.
If you’re investing in stock, the interest of this loan is tax-deductible. If you’re borrowing to buy a new car, the interest is not tax-deductible. Finally, if you’re investing in municipal bonds, interest won’t be deductible.
These loans have lower interest rates compared to other sources of unsecured loans such as credit card loans. This type of loan also has a tax-deductible interest which can go up to $2,500 annually depending on how much you earn. These loans have lower interest rates compared to other sources of unsecured loans such as credit card loans. This type of loan also has a tax-deductible interest which can go up to $2,500 annually depending on how much you earn.
Whether you want a personal loan or a business loan, the liability side of your balance sheet will affect your financial goals. A business entity can decide to manage its liability to add shareholder’s value. The same way, you can manage your liabilities to achieve your overall financial goals.
Borrowing money can make or break you if you don’t seek sound advice. You should never borrow recklessly even under the context of the guidelines highlighted above. Educate yourself first before taking any form of a loan.