29 July 2007

Fixing your Money Problems - 7

Part 7: (Loans & Credit Cards)

Most of the previous guides talked about very simple saving and spending issues; things most people don't really think about or consider, even though they are mostly common sense. Anyhow, in this guide I will start talking about borrowed funds; loans and credit cards.

Bahrain has a pretty big problem with loans and credit cards; a large part of the population have gotten themselves into debts they can't handle, and unfortunately don't have too much to show for it in return. A lot of people here take out loans and cards for the wrong reasons, and end up burying a financial hole for themselves; it's become a social dilemma, and as soon as someone works they 'HAVE' to take out a loan.

The whole situation with the problems of loans needs more awareness. If you're one of the lucky few who haven't yet taken out a loan or card, don't. Well, at least not until you know how to use them the right way; using them without being aware of the problems that can follow is just like pushing a self-destruct button. However, utilizing them the right way can do a lot of good for you.

Lets talk about loans specifically in this guide, and credit cards in the next one.

Loans:

The concept of a loan is very simple; you borrow a certain amount of money, and pay it back with interest, divided over a period of time. Most personal loans can be paid back for over 7 years, while other loans (mortgage, business etc) can be taken for as long as 30 years (some countries even go up to 50). In other words, you're spending tommorows money, today.

Human nature thinks about the period that is 'now', and what they need today. Loans deal with much longer periods that most people don't consider at first; so automatically we have a problem.

When you take out a loan, lets say the bank tells you "We'll give you five thousand dinars NOW for only a small payment of 85 dinars a month", so you think, great! I get the cash NOW, and 85 dinars is such a small return. Overall, if you consider a payment period of 7 years, you realize that you pay a total of 7,140 (ie, that's an extra 2,140 dinars). That isn't a small amount of money (its paying back a little under half of what you borrowed, extra).

What makes it worse, is when people spend the cash from their loans on perishable items; say you buy a laptop that might stop working, or become outdated after 2 or 3 years, and pay the loan back over 7 years. So even after you dispose of the laptop, you're still stuck with payments for a few more years.

This concept is the same for cars; you buy a car, brand new. As soon as you drive out of the showroom, its value goes down, and keeps getting reduced. On the other hand, your loan, with time, increases in value with the amounts and interest you have to pay. Again, some people buy a car and get bored of it 3 or 4 years down the line, and then sell it. They're still stuck with the payments, though.

This concept of using loans to pay for perishable items, and dividing items over longer periods than are reasonable is one of the bigger financial problems we have in Bahrain. Also, you don't consider the installment amount to be very high; suppose your salary is 500 dinars, and you get an loan where you pay 150 a month. That's fine; you think you still have a good 350 dinars a month to spend.

But then, you have your phone bill (20bd), your internet bill (another 20bd), your monthly gas expenses (40bd), among others. Lets assume with those fixed bills, you have BD270 left. Not so much, but still reasonable.

Now lets say you got married, and need an apartment, so you find a really cheap one for BD120 a month (which is very unlikely by today's property prices). So you have BD150 left. Ok, you might be pushing your budget a little, but at least you have your own place, right?

Oh but wait, there's also the electricity and water gas bills, and municipality payments. Lets say they come up to BD30? So now you have BD120. Is that even enough to live a reasonable lifestyle?

That BD150 you pay for your loan doesn't look so small now, does it? If you weren't paying it, you would have more than double the amount you have now to spend. Truth is, your expenses WILL increase with time. Unless you have a really good reason, having an extra loan expense for the future isn't really a great idea.

If you're considering getting a loan, THINK. Why are you getting one? If its to buy a bunch of things you want (want, ie, not things you need) ie, laptop, new furniture, etc, then its a really bad idea. If you're really stuck and need those items, at LEAST get a loan thats going to last as long as the items are. If you expect a laptop to last 2 to 3 years, don't get payments over 7 years! Sure, the installments are lower, but you're paying a lot more interest in the long run, plus you end up paying for the item long after it falls apart. If the payment is higher than you think you can afford, then the item is too expensive for you to own. Leave it, save, and wait till you collect enough to buy it.

I personally don't think any loan is worth getting for perishable items - save up for those, and buy them in cash. If you want to get a loan, get one when you're buying a property (ie, land, house etc), where the value of this item goes up as the value of the loan goes up, and sometimes, the property value exceeds the cost of the land (so you can sell it, pay off the loan and still come out with a good profit). Again, even getting a loan for an investment is still risky; you might buy stocks that crash and end up paying your loan for years for nothing. Just really consider why you're getting the loan.

Buying something with a loan? If you don't need it, it really isn't advisable to spend that money on it, since the cost of whatever you are buying is increased with interest. Always look at the total value you're going to pay back, don't look at the monthly installment - thats just a decieving factor.

I'll talk about loans in more detail later, and focus on what to do if you already have a loan. Next post: credit cards.

3 comments:

Hashim said...

Ammar,

I want to thank you for all your tips you mention here.

It's really sad that most of us Bahrainies are up to our eye balls in debt. I think a large part of it is because we're simply are not being paid enough. I think you were being modest in the examples you've given, but in reality, living off of a BD 500 salary just does not work! Especially if you're married, have children, and having to pay for education.

I think the last statistic i've read about this issue is that most Bahraini families have an average of BD. 10k in loans.

Ammar456 said...

its true; but the best thing to try to do is adjust. I hope this guide gives some people direction at least, or helps them in some way

Blue Ice Envy said...

OK this one is just common sense!