Just as a regular health screening can help to identify ailments early for remedies, a financial health check can help you discover areas of improvement in your financial well-being. Also, just like any health ailment, acting early can significantly prevent being caught in a sticky financial situation. In general, there are 3 key metric that we can use to monitor your financial health. First is your total savings, second is your debt service ratio and lastly is your total unsecured debt to monthly income ratio.
Let’s cover them here and you can give yourself a quick rating on each of them. In general, if you do not meet them, don’t worry as we have included some remedy steps for you.
Summary:
Savings is one of the easiest ways to measure a person’s financial health. This is because it tells you the amount of buffer an individual has to bear with financial shocks. It also allows you the flexibility to make transitory decisions like changing a job, taking care of your kid, taking a sabbatical without worrying too much about needing to keep an income. Therefore, a healthy rule of thumb is to have 6 months of your take-home salary in cash. If you make $3,000 after CPF deduction, you should have at least $18,000 in cash as standby in your bank account. Do note that this should not be confused with investments as your investments might not be as liquid as it seems and may fluctuate in value.
• Start a budget and work out your expenses. A quick guide is always using the 20-30-50 rule, whereby 20% is allocated to savings, 30% to investments and 50% for expenses.
• Begin by opening a separate account for savings, once then you can automate your savings by setting up a recurring transfer from your salary crediting account to your separate savings account on payday.
This is a tricky test to pass especially if you are a property owner and you are stretching out your loan. This simply means that your total debt repayment per month should not exceed more than 35% of your monthly income. This is capped at a 55% under TDSR if you are buying a private property. Most of the time, if you have taken a loan for your private property the ratio of 35% would likely have exceeded.
Also if you have an unsecured loan or taken a credit card loan, the monthly instalment should be managed carefully such that it does not exceed 35% of your income.
Here are two examples:
John has a monthly income of $8,500 and an annual variable bonus of $10,000. He buys a property that is $1,000,000 with a loan of $750,000 over 25 years. The monthly repayment at 3% p.a. interest rate is at $3,556.
This means that his Debt Servicing Ratio is: $3,556 / ($8,500 + 70% x 10,000/12) = 39% . Assuming that there are no other loan commitments.
• Property debt is a hard remedy as it is not as if you can easily dispose of the flat and choose something else. One way to help reduce the burden is to explore renting a part of your home. This can help to add to your income and reduce the overall service ratio.
• Alternatively, finding a co-investor or owner can help to reduce your service ratio.
Mary has a salary of $4,000 but has a credit card debt exceeding $50,000 and is paying an interest of 24% p.a. The minimum repayment on a credit card debt is 3% or $50. In this case, the min. repayment is $1,500.
Here we can see that her debt servicing ratio = $1,500 / $4,000 = 37.5%
• In order for her to reduce her service ratio, she can consider seeking a debt consolidation plan which is covered in our article in September.
• This way she is only subjected to a lower interest and gets to pay out her loan over 5 years. The only restriction is that she cannot take further debt until at least 50% of the amount is paid off.
It is extremely important to note one cannot simply focus on making minimum payments. With a large debt, you are simple inviting interest expense which in many minimum payments make up a bulk of it. In such situations, you do not actually reduce your debt as your payments are just for the interest. A key metric is when your total unsecured debt exceeds 12x. This is tipping point for most people where the interest expense becomes unbearable.
• Apply for a Debt Consolidation Program which helps to reduce your interest by 4x and stretch out your principal payment over 5 years.
How have you faired on the 3 scales? If you got perfect score, you are all set and ready to take on 2023! But do remember to also spend time to invest and prepare for retirement. If you scored less, fret not, follow our remedies and you will be back on track in no time. If you would still like some more advice or want to know more about Debt Consolidation, feel free to reach out to us here and we will be happy to help.
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