Every loan has a declared rate of interest. The interest could be a fixed rate or floating. It could be a combination as well, fixed for a few years and then adjustable as per the prevailing lending rates in the market. All standard loans are re-paid over a period and every instalment has a bit of the principal which is the loan amount and a bit of interest. Most loans are designed in a way wherein more interest is paid in the first few months or years and towards the latter half of the term it is more of the principal amount being re-paid and less of interest.

During an interest-only period, scheduled repayments cover interest but do not reduce the principal. When that period ends, repayments usually switch to principal and interest over the remaining loan term, so they can rise substantially. Interest continues to accrue; it is not paid off before principal repayments begin.

Pros and Cons of Interest Only Loan

The Pros

• An Interest only loan is beneficial for those who are looking at lower monthly repayments. Since the principal amount is not being considered in the initial instalments, the interest is split evenly into a certain number of months don’t amount to as much as it would had the principal been taken into the calculations.
• An interest-only structure does not itself create a tax deduction. Tax treatment depends on how borrowed funds are used and individual circumstances; obtain tax advice. Interest only loans are often opted for by property investors and commercial property owners.
• Interest only loans help property investors who don’t intend to hold onto an investment for too long. Selling at a profit is not assured. Property values may fall, and sale proceeds may not cover the debt and transaction costs.

The Cons

• An interest-only period leaves the principal outstanding and can increase the total interest paid. Consider whether you can afford the later repayments and whether this structure suits your circumstances.
• It also doesn’t make sense to allow the lender to make all the profit and then to keep repaying the principal amount which can go awry if someone loses a job or incurs losses in business.
• Not every lender offers interest only loans so there are fewer options available.

Debt is unavoidable. All of us have debts. For some people, the debts are simple obligations like utility bills. For many, it would be a credit card bill. From mortgage to paying back the student loan, people have myriad types of debts. It is almost impossible to avoid debts. Even the billionaires of the world have humongous business loans to repay. They continue to persist with those debts because they are necessary and they haven’t turned into bad debts.

There is good debt and there is bad debt. These labels are only shorthand: any debt can become unsuitable or unaffordable. Let us explore the simple differences between bad debt and good debt.

• A mortgage can help buy a home, but it is still a liability. Property values can fall, and interest, maintenance and transaction costs affect the result. Profit is not guaranteed.
• Bad debt is any loan that is unnecessary, is hitting your finances hard and may be getting unmanageable – those debts which are liabilities rather than assets. Skyrocketing credit card debt is bad because it is not necessarily leading to tangible assets and you would be paying high rates of interest. Personal loans and unsecured loans are also bad debts if you don’t have a very reasonable purpose. Allowing utility bills and other financial obligations to build up would also qualify as bad debts. You would have to pay penalties that are avoidable and your credit history could take a hit.

 

There are grey areas when it comes to good debt and bad debt. A car loan is neither good nor bad. Since cars are depreciating assets, you are better off purchasing one with a down payment or in cash. But if you don’t have enough cash or don’t want to use it up, then you need a loan.

It is not necessary to make debts complicated. Necessary debt with reasonable interests and when it is manageable is good debt. Any debt that is needless, demands high interests and becomes a burden is bad debt.

Buying a home is difficult. Buying a home when someone is very young is all-the-more challenging. Young professionals may be able to pay the instalments of the mortgage but saving enough to make the down payment is an uphill task. When one is in their twenties or even early thirties living in the city or when expenses are reasonably higher due to various experiences that the young usually indulge in, it becomes difficult to set aside the money needed to buy a house.

The down payment is the biggest financial challenge. The second challenge is qualifying for the mortgage. There are many lenders with varying rates, the eligibility criteria would be a hurdle and the homebuyer needs to manage their finances well so they can keep making timely payments without impairing their lifestyle. Your credit history will also play a pivotal role in the mortgage preapproval and approval process.

If you are planning to buy a house, you could get your parents or a family member to make some contribution in myriad ways. You may want them to pay a part of the down payment. You may even get them have a cash gift that takes care of the entire down payment. Parents often use the equity of their large home, a second property or an unused block of land to fund the down payment of their grownup child’s home. Families could contribute whatever amount of money they can afford and whatever would be useful for your mortgage.

A guarantor promises to meet obligations specified in the guarantee if the borrower does not. A guarantee may help with a deposit or security requirement, but it does not replace the lender's assessment of the borrower's ability to repay.

A guarantor may have to repay the guaranteed debt and could lose property used as security. The guarantee can also affect their own borrowing capacity. Approval, rates and processing times remain subject to the lender's criteria. Before signing, the guarantor should obtain independent legal and financial advice. See Moneysmart's guarantor guidance.

Bankruptcy is a legal provision that allows you to declare yourself incapable of repaying debts. You could be truly bankrupt, which literally means that you don’t have a penny in your bank. Realistically, you don’t have enough money to repay the loans or creditors and would want the debts to be waived off.

Bankruptcy can be obtained for due to personal reasons, including strife among spouses. Personal bankruptcy or insolvency can be due to unemployment or if your business has run into unbearable losses. There can be other causes such as failing health or some personal incapacity that prevents you from working and hence repaying your debts.

Bankruptcy is almost always looked at from the perspective of debt and it is a way to get relieved of the obligations to repay. However, what most people don’t realize is that bankruptcy can have serious and lasting consequences. Let us factor in these realities to understand bankruptcy.

• Bankruptcy generally lasts three years and one day, but can be extended. It does not release every type of debt.
• A trustee may sell some assets. Protected property and indexed limits apply, so it is incorrect to say all possessions will be sold.
• Credit reports generally record bankruptcy for five years from its start or two years after it ends, whichever is later. The National Personal Insolvency Index is separate and generally retains the record permanently.
• Bankruptcy can affect borrowing, business activities and some professional licences. It is not an automatic ban on all employment or a universal ten-year lending prohibition.

Seek independent advice before deciding. See AFSA: consequences of bankruptcy.

Investing is the quintessential key to financial planning. No financial plan, short term or long term, can be effective unless there is an investment strategy integrated into the approach. When you actually start investing, you would have to endure a learning curve. Knowing a few of the golden rules of investing can help you through the nascent phase and you can hone your skills, acumen and judgment as an investor.

• Start with your goals, time horizon and capacity for loss.
• Understand the investment, its fees and how readily you can sell it.
• Diversify rather than relying on one asset or market.
• Avoid pressure to act quickly or promises of guaranteed returns. Trying to time market movements can increase risk.
• Review your plan when your circumstances change. Obtain licensed financial advice when you need a recommendation tailored to you.

See Moneysmart: develop an investing plan.

 

Be a dedicated investor, check your investments, study and review your strategies.

Home loans or mortgages are designed to help any and every homebuyer, provided they meet specific prerequisites. From credit score to income, the loan to value ratio or the down payment to the type of employment or business one has, everything will be under consideration while determining eligibility. From employed and self-employed professionals, business owners and independent contractors or freelancers. The concept of the home loan doesn’t differentiate on the basis of the type of employment. However, the eligibility factors or the criteria for approval would vary.

The appropriate financing arrangement depends on the property, purpose and your circumstances. For self-employed professionals, the exact criteria will vary from one bank to another but the eligibility factors will be different from that of employed professionals.

• You would need your tax returns and financial statements. The purpose is to show how much in taxes you have been paying, confirming your income. The financial statements are assessed to deem financial eligibility, whether or not you can afford the instalment or the mortgage. There are various online home loan calculators that you can use to deem eligibility and how much you can comfortably afford towards a mortgage. For self-employed professionals, the approach to calculate dependents and other financial commitments is similar to that of employed people. However, some stringency is expected as self-employed professionals don’t have the financial security of employed professionals. Self-employed professionals may incur losses and may not earn anything in a given month or quarter.
• Trading-history and documentation requirements vary between lenders. They may request tax returns, financial statements, bank statements or business activity statements. GST registration is not a universal requirement for every self-employed borrower.
• The income, the GST paid, the taxes paid and filed for, business activity and the amount of money one can comfortably spare will determine the loan amount. There is no universal 80% borrowing limit for all self-employed applicants. The lender's valuation, product rules, insurance requirements and assessment determine the available loan-to-value ratio.

Retirement timing depends on your circumstances, expected expenses, savings, superannuation and other resources. There is no single retirement age or savings target that suits everyone.

Planning should allow for how long your income may need to last, your debts and dependants, and when you can access superannuation. See Moneysmart's retirement planning guide.

There are various kinds of funds that you can invest in. You could choose to manage your own funds or you may choose to have a fund manager. There are funds managed by banks, financial services companies, independent fund managers and there are special investment schemes designed by various institutions. You may invest in stocks, indices, specific commodities, foreign exchange or you can choose mutual funds and other types of managed or unmanaged funds. Most funds can be classified as active or passive funds. There are similarities between active and passive funds but it is the difference that calls for attention.

Active Funds: Explained!

Imagine a particular amount that you wish to invest in and pick an index of your choice. You could choose any index of any country. You may also choose global indices. If the fund you choose to invest in is managed by an expert and he or she tends to make manoeuvres from time to time, such as buying and selling or even withholding or future trading, to make you more money than you would make normally, then it is classified as an active fund. Active funds are managed to facilitate more profits than what you would make if you didn’t touch the fund and allowed the investments to bear the returns by default. Active funds are designed to predict the markets and respond or proactively take a step to make more money.

While active funds can make you more money, it is not always assured to get you higher returns.

Passive Funds: Explained!

Passive funds generally aim to track a market index rather than outperform it. They are still managed: holdings may be adjusted to follow the index. Fees are often lower than active funds, but returns can fall, and neither approach guarantees a profit. See Moneysmart's managed funds guide.

 

Making a household budget is quintessential to financial planning. It is rather simple to come up with a budget. You have your income, you can make a list of expenses you cannot avoid and then decide how much you wish to save every month. Accordingly, you need to cut corners somewhere, invest your money or save, try to increase your income and you should always look for smarter ways to save on unavoidable expenses. The real challenge is to adhere to a household budget. Here is how you can approach the whole daunting challenge of financial planning.

• Don’t spend money when you don’t intend to and don’t have to. Impulsive buying is the biggest threat to savings. Adhere to your grocery list, abide by the budget every time you wish to buy something and you would stick to the math.
• Be firm with your goal to save. This goal may be yearly, quarterly or monthly. But you must break it down to the least possible denominator. Put aside some money every week and that must be untouched savings.
• Limit your use of plastic money, especially credit cards. Use cash and you would naturally run out of it once you have exhausted your budget. To facilitate this, transfer the amount you wish to save from one account to another right after your pay cheque gets credited.
• Savings is a never ending exercise. You may not notice this but the little amounts you spend regularly on the mundane routinely coffee, lunch and snack outside actually end up costing you more than a thousand bucks. If you are living in a major city, then this cost would be up to two thousand and possibly more. Cut down on this expense and you could have handsome savings. Take a homemade lunch to work, avoid one cup of coffee every day or skip a few snacks or meals at fancy restaurants or expensive eateries when you can do without them.
• Avoid debts. From personal loans to credit card debt, all these commitments will cost you dearly. Do some math and check out how much you have paid extra in the last year or years as interest. This entire amount could have been your savings.
• Don’t shop on weekends. It may seem to be a daunting challenge to shop on a weekday or at a particular time on a certain day of the week but that is how you would get some amazing deals. Compare unit prices and buy in bulk only when it suits your budget, storage and likely use. Today, most homes have large refrigerators. You may not have larger than life freezers but you can stock up at least a fortnight’s worth of food. Bulk buying does not guarantee savings, particularly if food or other products go to waste.

Every working adult should know the financial basics. Very few people are proactively conscious of their financial wellbeing. Financial health is not just about your present income, your monthly expense and if you are living from one pay cheque to another or if you are managing to put aside a few bucks. You need to have a plan to have your financial affairs in order and in control for a predictably prosperous future. While it is difficult to perfect financial planning overnight, you have to get started somewhere. Get started with the financial basics.

• Always have your accounts organized. We aren’t talking about the bank accounts you have but a professional account of all your incomes, expenses, savings and investments. From your financial liabilities to your assets, everything should be well documented. You may consider a certain expense to be too tiny to find a mention in your account and some incomes may be deemed a surplus. Ideally, you should account for everything.
• Always keep an eye on the official cash rate. It is the standard set by the Reserve Bank determining the cost of borrowing money. More precisely, the cash rate is the rate on unsecured overnight loans between banks; the Reserve Bank sets a target for it. The official cash rate is reviewed from time to time. It goes up and down and remains constant. The focus is to keep a check on inflation but the rate affects all financial products, at least within the regulated banking and finance industry.
• Your mortgage and all other secured or unsecured but conventional loans will be influenced by the official cash rate. A mortgage is an asset in the making because the money you spend, even as interest, is actually getting you a property. Credit card interests and all other secured or unsecured loans excluding business loans would also qualify as debts with no major returns. These would have an adverse impact on your financial health.
• In addition to saving money, you must consider investing your savings. Savings can earn interest. Whether to invest depends on your goals, timeframe, liquidity needs and risk tolerance; higher returns are not assured. But make investment choices wisely as those too can wipe off your savings.

As always, we recommend speaking to your YFG specialist for expert guidance and assistance.