Look before you leap… into a loan

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You need to create a diversified safety net to offset adverse financial events before borrowing large sums of money

Buying a property is always a dream and owning several properties generally germinates a sense of being on Cloud 9 by setting a path to reel out of the Rat Race.

Does it really?

Nobody want dreams to leave sour pitfalls; thus it is imperative to understand the limitations which one may face in order to make an informed decision on borrowing large sums of money, whether it may be for a property or other investment. It is a process of self-reflection by the way of asking questions on what one needs to do to achieve investment goals.

Loan serviceability, positive cash flow, general well-being and family welfare are what one needs to look at when is looking at borrowing large sums of money.

These considerations are the key for any loan to deliver success which investors aspire. This month we will discuss the importance of loan serviceability.

Banks and financial institutions lend money based on the assumption that for the duration of the loan, which is generally in between 25 years to 30 years, the borrower will have the same or added income in order to pay off the loan. Would we have an adequate income stream for the duration of the loan to pay off the loan in its entirety? This is a basic, but important question to ask. One can argue that the availability of the future income stream is not a critical factor and in the worst case, where the loan cannot be paid off, the bank or the financial institutions can take over the property and liquidate to service the remainder of the loan. However, this is not a type of legacy one would like to pass to their children and family. This will impact the general reputation and the credit rating. Bad credit rating diminishes the ability to access a home loan, personal loan, credit card, phones on plans or any other form of credit in the future.

In today’ agile employment environment where jobs are not sustainable and people rely upon ad hoc contract work, casual and part time employment; it is not practical to guarantee steady income for long durations. A careful thought process is required to ensure the sustained stream of repayments. A contingency plan should be put together to fall back upon during the unforeseen events. Consideration should be given to understand that if one back-up mechanism of the contingency plan fails then how other adverse events will be prevented.

A common mistake I have seen in risk planning is that the people hinge their whole range of risks on one or two risk mitigation measures. Perhaps the better way to have a robust contingency plan is by creating a diversified safety net. Diversified safety net is mechanism where the contingency plan includes multiple and different back-up mechanisms to offset one or multiple adverse financial events. Diversified safety net could be a mix of high proportion of equities in the properties, income protection insurance, mortgage insurance, additional savings by cutting down house hold expenses, negative gearing, a set of liquid assets and a good credit rating.

The safety net shall also include a consideration to upskill yourselves to improve your employability in an ever evolving job market and stay ahead of the curve.

Next month, we will discuss the importance of Cash Flow and its role in managing feasible loan repayments. Positive cash flow is important to ensure your routine living expenses are not compromised by loan repayment obligations and vice versa.


The writer is an entrepreneur, financial influencer and manages regulated businesses and commercial property portfolio. He is experienced investment strategist and enjoys delivering investment contingency plans. A confident leader with a passion for social welfare and upliftment of migrant communities.

 

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