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Agensi Kaunseling dan Pengurusan KreditAras 8, Maju Junction Mall1001, Jalan Sultan Ismail50250 Kuala LumpurFax : 03-2616 7601 E-mail: enquiry@akpk.org.my

© AKPKFirst Edition 2011

The copyright of this book belongs to Agensi Kaunseling dan Pengurusan Kredit (AKPK). This book or parts thereof, may be reproduced, translated, or transmitted in any form with prior written permission from AKPK only for the sole purpose of education. No monetary gain in any form should be made or derived, whether direct or indirect from such reproduction.

ISBN 978-983-44004-2-2

Disclaimer:

The information contained in this book is solely for educational purpose. It is not intended as a substitute for any advice you may receive from a professional financial advisor.

Agensi Kaunseling dan Pengurusan Kredit (AKPK) disclaims all and any liability to any person using the information in this book as a basis for making or taking an action.

While all efforts have been made to make the information contained in this book accurate, AKPK seeks your understanding for any errors or omission.

The names and details of individuals in the real life cases have been changed to protect their identities.

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Chapter

2BORROWingBasiCs

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With numerous loans and credit cards offered by financial institutions in the market today, you may be tempted to spend more money than you actually have through borrowings.

Borrowing from financial institutions allows you to obtain money on loan or get a line of credit to enable you to buy a house, car, pay your bills or even go on holidays.

Although a loan is beneficial, particularly in helping you pay for big purchases, it is crucial for you to keep in mind that the money you borrow is not free. Money on loan needs to be paid back – with interest and penalty charges when it is repaid late!

Credit and debt

Credit is a facility to borrow with an agreement to repay the creditor, as per the terms and conditions outlined in the contract.

When you borrow, you are taking on credit and when you use a credit facility, you are taking on debt.

“ To borrow or not to borrow, that is the question!”

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You are given a credit card with a limit of RM3,000. If you have spent RM1,000 on your credit card, that RM1,000 of utilized credit now becomes a debt. BEFORE : RM3,000 credit availableaFtER : RM2,000 credit still available

RM1,000 debt owing

Why DO yOU BORROW? When you borrow, you need to ask yourself what is the purpose of your loan. Keep in mind that you should only borrow to meet your needs and not your wants.

When you want to take a loan or use a credit card to purchase something, ask yourself the following questions:

• Is the product or service I intend to purchase a need or a want?

• Can I afford to pay the installments?

• If it is a substantial purchase, such as a car or house, can I pay a larger down payment?

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It also helps to know the general rules of borrowing.

Rules of borrowing

Borrow for productive purpose only and for something that you really need but do not have enough cash to pay for. This includes buying a house or a car, sending your children for further education or meeting emergency needs.

Borrow within your means. You should only borrow an amount that you can pay back comfortably. It is recommended that your total monthly repayments should not exceed 40% of your gross monthly income.

a borrower has a moral commitment to repay as there should be no excuses for not repaying your debts. Always bear in mind that your creditworthiness will be affected if you do not repay your loans according to the terms of repayment.

Here are some examples of productive debts versus unproductive debts:

Money borrowed at Taking a new loan to pay ancompetitive rates to invest existing loan without anyin quality assets cost saving

A housing loan that is being A high interest personal loanpaid off in a planned manner to pay for holiday or other lifestyle costs

As highlighted in the chart above, borrowing for the right reasons can help enhance your overall net worth. Now that you know why and when you should borrow, let us look at the sources of borrowing.

PRODUCtiVE DEBt(Buying appreciating assets)

UnPRODUCtiVE DEBt(Funding lifestyle)

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COMMOn sOURCEs OF BORROWingThere are various financial institutions in Malaysia that provide financing. The following are common sources of borrowing:

Licensed Financial institution (LFi)

LFIs include commercial banks that are licensed by Bank Negara Malaysia (BNM) to provide credit facilities to the public. You are strongly advised to borrow from a LFI as there are rules and regulations in place to safeguard your rights.

Browse the website of BNM www.bnm.gov.my for a complete listing of LFIs

Co-operatives

Co-operatives are regulated by the Ministry of Domestic Trade, Co-operatives and Consumerism (MDTCC). Members of the co-operatives may borrow from their co-operatives based on their eligibility and other criteria set by their management.

Licensed Money Lender (LML)

LMLs are lenders licensed by the Ministry of Housing and Local Government to provide loans to the public. However, unlike licensed financial institutions, they cannot accept deposits and their rates are normally higher than LFIs. So, it is advisable that you always check the rates offered by these LMLs before taking a loan.

Unlicensed Money Lender (UML)

UMLs are illegal and commonly referred to as ‘Loan Sharks’ or ‘Ah Longs’. You should never borrow from UMLs. UMLs offer unsecured loans at very high interest rates with vague and strict terms and conditions. These UMLs resort to threats and violence on people who cannot repay their loans.

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TYPES OF LOAN

securedloans

• Backed by assets and normally easier to obtain

• In the event of default, the lender will be able to take possession of that asset and sell it to recover the loan

• Some examples of secured loans include a housing loan and car loan

unsecuredloans

• Not backed by any assets

• Re l i es on you r ability to repay the loan and your credit background

• Generally smaller in amount, shorter in tenure and have h i g h e r i n t e re s t rates

• In order to mitigate t h e h i g h r i s k , lending institutions sometimes require a g u a r a n t o r t o guarantee the loan

• Some examples of unsecured loans include credit card outstanding and personal loan

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isLaMiC BanKingIslamic banking is a banking system licensed by BNM that follows Shariah (Islamic laws) principles, which prohibits Riba (collection and payment of interest), Usury (the act or practice of lending money at an exorbitant rate of interest), trading in financial risk and Haram (unlawful) business ventures.

In Malaysia, we have the opportunity to choose between conventional and Islamic banking systems. Contrary to what some people might think, Islamic banking is for all individuals regardless of their religious beliefs.

Islamic banking operates according to Shariah rules on transactions, known as Fiqh al-Muamalat. The basic principles of Islamic banking are the sharing of profit and loss and the prohibition of riba. Some common concepts used in Islamic banking include partnership (Mudharabah), safekeeping (Wadiah), profit-sharing (Musharakah), cost-plus (Murabahah) and leasing (Ijarah).

Islamic banking products in Malaysia are monitored by the Shariah Advisory Council set up by BNM in addition to the bank’s own internal Shariah review committee.

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What DO FinanCiaL institUtiOns LOOK at?When you apply for a credit card, personal loan, or any other type of credit, the lender must first evaluate if you are a good credit risk. When assessing credit risk, a lender looks at the ability of a borrower to meet loan obligations which will to some extent determine the pricing of the loan.

The success of your loan application largely depends on thefollowing:

the 3Ps of credit

Lenders want to know why you are borrowing to assess the risks involved. The type of loan is then matched to your purpose for borrowing. If you are buying a house, then it is a housing loan while a hire purchase loan would be given to finance a car. The purpose and whether the loan is secured or unsecured will, among others, determine the interest rate and tenure of the loan

Your repayment capacity is vital. Lenders are keen to see enough surplus income or cash reserve to meet your new financial commitments. They would like to be assured of your stable income or continuity of employment. Here, your cash flow position is being evaluated. An important indicator of your payment ability is your debt-to-income ratio

1

2

Purpose of borrowing

Paymentability

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En. Daud’s gross monthly income is RM3,800. His total monthly loan repayment - housing, car payment and credit cards is RM2,128. Debt-to-income ratio = Monthly loan repayments

Gross monthly income

= RM2,128 X 100%

RM3,800

= 56%

3 Payment history

Your past track record on repayments of your earlier or existing loans are looked at to determine what type of paymaster you are. If your repayment records are not satisfactory, your chances of getting a new loan may be slim

DEBt-tO-inCOME RatiOA debt-to-income ratio indicates a person’s total monthly loan repayments against his gross monthly income. A high ratio indicates that a person may not have enough cash for his monthly needs.

Let us illustrate this point by working out an example of a debt-to-income ratio for Encik Daud:

As a general rule, your total monthly repayment on all your loans and credit card debt should not be more than 40% of your gross monthly income

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As you can see, En. Daud’s debt-to-income ratio is higher than the recommended amount. In this scenario it is best that he strives to bring down the ratio.

So how do you bring down your debt-to-income ratio?

You can either increase your income and/or lower your loan commitments.

It is important not to overcommit on loans and purchases using credit cards as this would have an impact on your ratio and in turn may affect your creditworthiness.

BEing a gUaRantOR When an individual’s creditworthiness is questionable, lenders would normally request a guarantor to guarantee the loan.

A guarantor is not the principal borrower. However, a guarantor is still responsible for the unpaid portion of the loan, including interest if the principal borrower defaults.

The guarantor’s guarantee for the borrower’s obligation will last until full settlement of the loan.

A guarantor cannot be discharged without the full settlement of the loan or prior to obtaining the lender’s consent.

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guarantor’s no guarantee Age : 28 years oldOccupation : Engineer Marital status : Single

Sam and Ling were in a relationship. They met when they were both students at a local college. After dating for a couple of years, Ling asked Sam to become the guarantor for her HP loan. Sam agreed to the request immediately and signed the guarantee without hesitation.

As Sam decided to be the guarantor for Ling’s HP loan out of love and affection, he did not seek advice from anyone before signing the guarantee. In addition, Sam was also confident that Ling would repay the HP loan on schedule and that they would be married soon.

Three months after becoming a guarantor, Ling started defaulting on her HP loan repayments. Sam helped Ling to pay for her arrears until he found out that Ling was engaged to be married to another man. Shocked and broken hearted upon discovering Ling’s engagement, he broke contact with her, changed jobs and moved to a different state.

Unknown to Sam, Ling continued to default on her HP repayment and changed jobs and homes frequently. As Ling did not service her loan, the financial institution repossessed and auctioned her car. After the sale, there was still a shortfall of RM45,000 owing to the financier.

As Ling could not pay the shortfall from the auction, the financial institution demanded the shortfall from Sam instead as he was the guarantor for the loan. However, even for Sam the shortfall amount was too big to pay off.

Due to his inability to cover the shortfall, the financial institution initiated legal proceedings against Sam to recover the outstanding. Worried about his financial predicament, Sam sought AKPK’s advice.

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EFFECts OF intEREst RatEInterest is cost paid for the use of borrowed money or money earned on deposited funds. The interest rate charged on loans is a measure of the risk that the lender takes in providing the borrower with money – the greater the perceived risk, the higher the interest rate.

Generally, there are 3 types of interest rates quoted in the market. They are:

Flat rate Interest calculated upfront on the amount of money borrowed over the entire loan tenure

Fixed rate Interest calculated based on a reducing balance basis, whereby the interest rate does not fluctuate during the loan tenure

Floating rate Interest calculated based on a reducing balance basis, whereby the interest rate is tied to an index or base rate and fluctuates over the period of the loan. The most common index or base rate used is the Base Lending Rate (BLR)

Flat interest rate is generally more expensive as it is calculated upfront on the loan amount over the entire loan tenure. This differs from fixed and floating rates, which are calculated on a reducing balance basis.

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Understanding compound interest

Compound interest is just like a series of simple interests, where the interest incurred is added to the original principal, which is then considered as a principal for the next period. Compounding can be done annually, monthly or daily – the more frequent the compounding, the larger the interest effect.

Compound interest thus can be a double-edged sword – while it helps to give more return on investments, it also results in more interest being charged if there is a delay in repaying a loan or credit card debt. A common application of such method is in the computation of a credit card loan which will be covered in Chapter 3 and also housing loan computation in Chapter 5.

Bank negara Malaysia’s (BnM) guidelines on product transparency and disclosure Recognizing the importance of adequate and effective disclosure to consumers and financial service providers, BNM has issued the Guidelines on Product Transparency and Disclosure. These guidelines serve to raise the disclosure standards for retail financial products and aim to support informed consumer decision-making through meaningful and timely disclosures.

In view of this, BNM requires financial service providers to disclose retail financial product features to help you make informed financial decisions. You are advised to request and understand the product features before deciding to accept any loan facility.

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• Borrow to meet your needs and not your wants; borrow for productive purposes only

• Borrow within your means – try to keep to a debt-to-income ratio of not more than 40%

• When you borrow, keep the 3Ps in mind:

– Purpose of the loan

– Payment ability (repayment capacity)

– Payment history (having good track record)

• Understand the different types of interest and the effects they have on your total borrowing costs

• Think carefully before agreeing to become a guarantor because if the borrower cannot or refuses to pay, you are liable!

takeaways

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Checklist

Do you know your total cost of borrowings?

Calculate your current debt-to-income ratio. Is it below 40%?

Do you know the due dates of all your loan installments?

Are you a guarantor to any loans? If yes, is the borrower paying on schedule?

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sELF assEssMEnt

1. Interest rates for unsecured loans tend to be __________

a. lowerb. higherc. constantd. flexible

2. The following are credit assessment criteria used by financial institutions when evaluating a loan application:

a. Payment abilityb. Payment historyc. Purpose of borrowingd. All of the above

3. Your debt-to-income ratio should NOT be more than _______

a. 40% of your gross monthly income b. 40% of your expenses c. 40% of your net income d. 40% of your debt

4. If you are a guarantor, the bank can __________

a. ask your friends (not guarantors) to pay the outstanding amount

b. seek repayment of the loan from family members (not guarantors)

c. ask you to repay other loans owed to the bank not guaranteed by you

d. ask you to pay the outstanding amount if the borrower fails to pay

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5. Which of the following statement(s) explains compound interest?

a. Interest incurred and added to the original principal which is considered as principal for the next period

b. Interest is charged on the principal loan only

c. Interest is charged on the unpaid interest portion only

d. None of the above

6. Which of the following is true with regards to Islamic Banking?

a. Licensed by Bank Negara Malaysia

b. Follows Shariah (Islamic laws) principles

c. Sharing of profit and loss

d. All of the above

Check your answers at the end of this book

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