Chapter 13

Debt Management in Retirement Planning

Chapter Objectives
Students must be able to:
 Computation of Housing Loan Installment that Offer Interest on Multi-rates Basis

 Evaluate Housing Loan Package Based on NPV and RR

 Benefits of Refinancing a Housing Loan

 Share Financing

 Implication of Margin Call in a Bear Market

 Overdraft as a Banking Facility and its Interest Calculation

 Other Fixed Loans for Financing

Introduction
- Whatever reduction in expenses that include interest expenses means that the
retirement annual income will be able to last longer.
- In this chapter, the focus is on financing of investment assets and some of the
liabilities incurred by individuals in their course of running a business or in their
attempt to assist family members, relatives and friends. We shall start with housing
loan, touching on computation of loan installments and the cost of borrowings.
Other loans such as share financing and overdraft facilities will also be covered.
- It should be clear that we are not encouraging people to borrow money for the
purpose of accumulating fund for retirement.

Housing Loans as Consumption Credit

- Many financial institutions seem to have compromised on the prudent lending
policies. Some of the banks are now granting a housing loan with repayment of
installment lasting until a person is aged 70! This implies that retirees may have to
continue to pay housing loan installments until they are aged 70 (during retirement
age).
- Obviously, a retiree with such commitment but has no active income will have to
rely on his retirement income to pay for the installments.
 - It is important to advise the client to settle the housing loan before they reached
retirement age by selecting the housing loan with appropriate tenure.

Selecting a Housing Loan Package

Total Interest Expense as a Selection Criterion
- One of the criteria that can be used for selection of housing loan offer is based on
total interest expenses charged. Under this approach, total interest expense of loan
offers are computed based on loan amount and the multi-interest rates charged and
the loan tenure.
- Whichever package that provides the lower total interest expense is considered in
favor over the others.
- From the viewpoint of a rational borrower that prefers lower interest expenses, the
approach seems to make sense. However, not too many individuals are trained to
handle the calculations of total loan interest especially when multi-tier interest rates
are involved. We shall make use of financial calculators in our approach.
Computation of Total Interest
For purpose of illustration, let us assume that an individual, Mark Taiko is offered a 10-
year housing loan of RM1million under Package A with interest rates of 2.38% in first
year, 5% in the second year, 6.35% in the third year, and 6.25% in the fourth and
subsequent year. How much will be the total interest payable of this loan package if
interest rates are assumed unchanged and installments are promptly paid?

In order to compute the total interest charged, we will first compute the monthly
installments for each and every year. Thereafter the total loan installment amount that
comprises principal repayment and interest can be summed up. Subtracting the original
principal loan sum from the total loan installment amount will give us the total interest
expense.
The monthly installments of the multi-tier rates loan are computed using financial
calculator as follows:
Total interest is then computed as follows:
Year Installment No. of Total Amount
amount installments Repaid
1 RM9,732.52 12 RM112,470.24
2 RM10,484.82 12 RM125,817.84
3 RM11,025.29 12 RM132,303.48
4 to 10 RM10,989.31 84 RM923,101.82
Total RM1,293,693
Less original loan amount RM1,000,000
Total interest RM293,693

Admittedly, the calculations are by no means simple. Fortunately, such complexity in

computation of interest expense is overcome by the availability of computer software. At
first glance, the interest expense approach makes sense as it enables house purchasers to
save interest expenses.
Let us assume that Mark Taiko is offered another Loan Package B with interest rates as
follows:
First year: 3.38%, Second year: 4.25%, Third year: 6.25%, Fourth year: 6.20%
We will the total interest of this loan package based on the assumption that all variables
are similar to that of package A except for the interest rates. The total interests of the
second loan package are summarized as follows:
Year Installment amount No. of Total Amount
installments Repaid
1 RM9,832.47 12 RM117,989.64
2 RM10,204.74 12 RM122,456.88
3 RM10,998.82 12 RM131,985.84
4 to 10 RM10,980.84 84 RM922,390.56
Total RM1,294,823
Less Original loan Amount
RM1,000,000
Total RM294,823 Interest

Based on interest expense as the criterion for selection, Package A that charges lower
interest of RM293,693 is considered a better offer.
Refinancing of Housing Loan
- Refinancing of housing loan is another hot topic which many consumers are
confronted with. The numerous advertisements by commercial banks to attract
existing housing loan borrowers from other banks seem to be an unending affair. As
a financial planner, how do we analyze the proposals?
- The approach is actually the same as what we just the existing loan outstanding
taken as the new loan amount, remaining tenure as the demonstrated. Other factors
that also be considered are as follows:

Loans with Fixed Rates or Variable Rates:

- Financial planners should be aware that interest rates offered by commercial banks
may be broadly classified under two categories. One category is to peg the lending
rates to the base lending rate (BLR).
- The other category is to provide fixed lending rates. When rates are pegged to the
BLR, the interest rate charged shall move in accordance with changes in base
lending rates. For illustration, let us examine a loan with BLR + 1%. If the BLR is
6%, BLR + 1% simply mean 6% + 1% = 7%. If BLR is reduced to 5.75%, the
lending rate will automatically be changed to 5.75% +1% = 6.75%. On the hand, if
BLR goes up to 7%, the lending rate will be 7% + 1% = 8%.
 - For lending based on fixed interest rate, changes in BLR will have no impact on the
interest expenses. No one can tell with certainty the movements of base lending
rates. What is certain is that a downward trend will favor those borrowers whose
rates are pegged to BLR. On the other hand, an upward trend will penalize
borrowers whose rates are pegged to BLR. If a borrower feels that the existing rates
are low enough and the room for downward movement is minimal, he should choose
offers with fixed rates. On the other hand, if one feels that the room for downward
adjustment in interest rate is still very promising, he should choose rates that are
pegged to BLR to enjoy the further reduction in rates.

Prepayment Charges
- Prepayment charges are additional charges imposed on the loan account when a
borrower fails to keep the account for a minimal time period with the lending banks.
Some commercial banks in their attempt to attract housing loans from other banks,
have offered many benefits such as paying for the movement fees from other banks.
Such costs include paying for the solicitors’ charges, incidental expenses and the
stamp duties on the loan refinancing. If the loan accounts are not kept in the banks
for a certain period, the commercial banks will not be able to break even. Hence,
 prepayment charges are imposed on accounts that fail to last the minimum time
period.

Housing Loans with Overdraft Supplement

- Some loan offers come with overdraft lines. A major benefit of an overdraft facility
is its flexibility in allowing repetition in usage as long as the amount is within the
approved limits. This advantage can turn out to be a weakness as the liability may
never be settles, especially if users are financially not disciplined to control usage
and repayment.

Loan Offers that Allow Repayment Term up to Age 70

- The advantage of allowing repayment term up to age 70 is to enable borrowers to
take up higher loan amount. From the viewpoint that most people would have retired
by age 55 or 60, the repayment ability at such advance age is questionable. For the
self-employed, the loan offer is tolerable provided they are in good health to
continue to be gainfully involved in business.
 - Otherwise, it is advisable that loan repayment should stop when a person reaches
retirement age. Another measure is to obtain appropriate insurance cover risk of
inability to work and loss of income.

Share Financing
- Stories of Warren Buffet and other successful tycoon in share investments have time
and again inspired many young and ambitious individuals and professionals. To get
rich by investing in shares is one of the exciting goals in life.
- The ways and means to riches include selection of undervalued shares that involve
gearing and financing. Therefore, one of the common types of loan incurred by
individuals is the loan for the purchase of stocks and shares. The lenders in this area
are however not confined to the commercial banks and finance companies.
Stockbrokers or investment bankers are also active in this lending business.
- While commercial banks obtained their funds for lending mainly from depositors,
the stockbrokers usually sourced their funds from commercial banks. The
implication of this source of funding suggests that costs of loans from stockbrokers
in financing are usually more expensive than the rates provided by commercial
banks. The impact of higher cost of financing cannot be underestimated. Apart from
cost of funds, there are other areas such as collateral and margin of financing and
 procedures on forced selling that are ought to be understood. Last but not least, the
risk associated in share financing must be appreciated. Debt management on share
financing cannot be complete without mention on the timing of entry and exit from
the share market.

Benefits of Financing
Assuming that Tony Wong and Donny Kong both have bought similar quoted shares of
equal quantity in Bursa Malaysia that cost RM300,000 each. Tong Wong obtained a loan
of RM200,000 at interest rate at 12% p.a. monthly rest, whereas Donny Kong paid cash
for the RM300,000. One month later, the shares gone up by 20%, the profit of Tony and
Donny (assume zero transaction costs) are as follows:
Tony Donny
Value after 1 month RM360,000 RM360,000
Less interest 2,000 0
Less purchase price RM300,000 RM300,000
Profit RM58,000 RM60,000
Capital RM100,000 RM300,000
Return on Investment 58% 20%
- The computations show that Tony with an initial capital of RM100,000 is able to
achieve a net profit of RM58,000 or a net return of 58% in a month with the help of
financing. For Donny who did not rely on financing, his net profit was RM60,000
but the margin was much lower at 20% when compared to what Tony has achieved.
This case example shows the positive side of financing in a bullish market.

- When market turns bearish, investors ought to know the losses and consequences
involved. For illustration, let us assume that the market value dropped 20% from
RM300,000 to RM240,000. The P&L account for Tony and Donny is the revised as
follows:

Tony Donny
Value after 1 month RM240,000 RM240,000
Less interest 2,000 0
Less purchase price RM300,000 RM300,000
Loss RM62,000 RM60,000
Capital RM100,000 RM300,000
Return on Investment -62% -20%
The computation above indicate that the loss of Tony would be much higher in term of
absolute profit figure and percentage. The story of losses would not end here and will be
examined under the margin call of this chapter.
Collateral for Share Financing
Common types of collateral used for share financing are as follows:
a. Quoted shares

b. Real estates

c. Fixed deposits

In general, shares that are quoted may be categorized into 4 categories:

1. Group 1: Usually the blue chips

2. Group 2: Shares that are slightly inferior to the blue chips

3. Group 3: Acceptable shares that are fairly priced

4. Group 4: Unacceptable shares for financing

Real estates may be further subdivided into different categories, namely, residential
properties, commercial properties, industrial properties, agricultural properties, hotel and
resort and golf courses.
Fixed deposit is commonly used as collateral for share financing also. In this case,
interest on the fixed deposit will not be allowed to be withdrawn. They are either credited
into the account or renewed along with the fixed deposit when they are due for renewal.
Different collateral will have different impact on the loan administration and credit
policies and practices. Common administrative works are valuation of collateral from
time to time. Different margin of financing is granted under different types of collateral.

Margin of Financing
Margin of financing may be defined as the percentage of shares acquired that is financed
by loans. When Tony Wong bought RM300k shares and 2/3 of the value is financed by
loan, the margin of financing is 67%.
There are other factors that affect margin of financing. The quality of collateral is one.
When quoted shares are offered as collateral, there can be different margins for different
categories of shares bought.
The margin of percentage of financing shall decrease with the quality of shares. For
instance, margin of financing may be 75% for Group 1, 60% for Group 2 and 50% for
Group 3.

Margin Call: This refers to the call for additional collateral when the amount of loans
outstanding exceeds the approved margin. It can happen either because the value of
shares or collateral has dropped or when the loan outstanding increased due to interest
debited into the account.

For example, let us review the case of Tony Wong when the market value dropped to
RM240k after 1 month. In the case of Tony, the bank would usually require him to top up
with more shares or other acceptable collateral or reduce the amount owing to the bank so
that the margin of financing remains status quo before the market drop. The margin of 2
to 1 was applicable in Tony’s case. This means that for every 3 dollar Tony has in shares,
he gets 2-dollar financing. When total share value dropped to RM240,000, Tony would
only be entitled to 2/3 or RM160,000 as financing amount. However, the loan of
RM200,000 plus interest of RM2,000 after 1 month is what Tony would have owed.
He has to reduce the loan outstanding by RM42,000 (RM202,000-RM160,000) in a short
period of time, usually not more than 1 week.
As an alternative, if Tony wish to top up with more shares as collateral, he has to increase
the value to RM202,000 x 1.5 = RM303,000. This means that he has to bring in
additional shares worth RM63,000 (RM303,000 – RM242,000) as collateral.
Active fluctuation in share prices can be a nuisance to borrowers when facilities had been
utilized up to the hilt. Usually, borrowers are given verbal notice to rectify the loan
position and if they do not comply, written notice shall be served. Such notice will
include a reminder of the rights of the financier to sell the sales to bring the margin of
financing within pre-agreed limit. Selling of shares will be done regardless of the marker
condition. In other words, when market is down with very poor prices, selling will still be
made. Such force-selling will only bring about further declines in prices and worsen the
infringement of the approved advance margin.
The breach of advance margin can also happen at the beginning of every month because
of interest debiting at month end. The shortfall can be covered by payment to cover
interest. Otherwise, additional collateral will be called for by the bankers. It is indeed
very unpleasant and give borrow no peace of mind. To mitigate the undesirable effect of
such margin call, borrower will have to avoid using the credit facilities up to the hilt. In
other words, usage of facilities should provide a room for the downside movement of
shares. Alternatively, borrowers should try to avoid collateral that fluctuate in values
frequently. This means that instead of using shares as collateral, they can use other
collaterals such as fixed deposit, the value of collateral can only go up due to interest
accumulation.

Implication
It is best that ordinary client be refrained from borrowing to invest. If at all borrowing to
invest in shares is unavoidable by choice, it should be done at the right timing. When a
person is young and is still in the accumulation phase, it may be an acceptable way to see
net worth growing quickly. Nevertheless, if a person is already in the retirement phase or
consumption phase, borrowing to invest is not recommended at all. The entire retirement
fund could be eroded and emptied within weeks if discipline is not exercised!

Loans to Acquire Other Landed Properties

Apart from buying residential properties, individuals are quite fond of buying other
commercial properties such as shops, office lots and factories and investments. Investors
who acquire these types of real estates are expecting rental income and property gain.
These forms of investment are usually financed by commercial banks or other financial
institutions. It follows that liabilities or loans are created in the process of investments.
Our topic on debt management has no choice but to cover this area of financing which
many retirees could get involved.
Loans available for the purchase of these real estates are usually in two main forms:
a. Overdraft and/or
b. Fixed loan

Overdraft
Under normal banking arrangement, a current account allows the account holder to issue
cheque to draw amount available in the account. If there is no accommodation to allow
the account to be overdrawn, any drawings in excess of the available balance will render
the cheque dishonored. When overdraft limit is provided for purpose of purchasing
properties, the account may be overdrawn up to the prearranged limit to pay for the
purchase. We shall use a case for illustration on the utilization of overdraft and the costs
involved.
Supposing Mathew has bought a shop house costing RM1 million with financing from
CC Bank. The facilities approved for this purpose are:
a. Overdraft: RM250,000
b. Fixed Loan: RM350,000
c. Total: RM600,000
Question:
How is Mathew going to repay the total loan of RM600,000? How can the cost of
borrowing be reduced? What advices are to be given?

Suggested solution
We can differentiate the two types of banking facilities, namely overdraft and fixed loans,
for this purpose.
Fixed Loan
Fixed loan is usually repayable by monthly installments. In some case, quarterly
repayments are also allowed. Monthly repayment amount is to be by equal monthly
installments. The computation of monthly installment is similar to the calculation of
housing loan installment. The following some but not all the criteria commonly used:
a. The age of borrower. Loan tenure is influenced by this factor.

b. The income of borrower. Installment and other financial obligations should not
exceed a certain percentage of total monthly income.

c. The rental income that can be generated from the property. Used as an indication of
the nature and quality of investment. Some banks do want to exclude it to see
whether borrower can repay when the property is fell vacant for whatever reason.
The risk of lending becomes high if the rental income is the only source of
repayment.

d. Past banking experience if the client is an existing customer. A good customer can
be seen by its existing accounts with the bank. Obviously, if existing accounts are
poorly conducted, to lend more will only increase risk exposure.
 e. Related account and the conduct with the bank. A related account may be defined as
any of the following relationship:
 Sole proprietor account where borrower is the sole proprietor

 A partnership account wherein borrower is one of the partners

 A limited company wherein borrower is a director or significant shareholder

 An account that is guaranteed by the borrower

 An account that is secured by similar collateral

When related accounts are poorly conducted, banks may not even want to consider
lending extra. The total financial obligation of all related account should be aggregated
before deciding on the installment amount.
In the housing loan sector, commercial bank has granted loan with tenure up to 30 years.
However, in the commercial loan sector, such loan tenure has been limited to no more
than 15 years usually. The rationale or argument is that an acquisition of shop house or
commercial property is a business investment; if an investment cannot break even in 15
years, it should not be regarded as a viable investment!
The interest rate of commercial loan is more expensive than a housing loan. Usually, a
higher interest rate is imposed on loans that are considered higher risk. In this case, the
cheaper rates available to housing loans are due to the existence of Cagamas Corporation.
Cagamas was formed as a government agency to encourage house ownership. It
encourages financial institutions to provide housing loans to individuals by purchasing
the mortgage papers from these commercial banks. The loans granted by financial
institutions therefore get the necessary funding. In addition, the sale of these loans to
Cagamas enables financial institutions to earn a profit margin without any asset on
balance sheet. The return on asset will naturally be enhanced by such housing loan
lending activities. Consequently, the return on equity will also be enhanced as the
weighted risk assets that need capital support is not increased by exposure to housing
loans.

In view of the aforesaid, while the interest rates for housing loans may be below 6% in
the first few years and increased to slightly above 6% thereafter, interest rates for
commercial loans should be higher. Therefore, borrowers of commercial loans should
bear in mind and be prepared for higher rates in the form base Lending Rate plus a spread
to reflect the risk of lending. A BLR + 2.5% suggest that interest rate will be 6% + 2.5%
= 8.5% if the BLR is 6%.
We shall two case examples, one to show the calculation of monthly installment, and
another to show how to calculate the quarterly installment. In both cases, we shall assume
that the loan amount shall be RM350,000, loan tenure of 15 years and interest rate of
8.5% per annum.

Financial calculator to simplify the computation is as follows:

HP (Input) Display Casio (Input) Display
12, Shift, 12
P/YR
15, Shift, N 180 15, Shift, n 180
8.5, I/YR 8.5 8.5, Shift, i% 0.708333
350000, PV 350000 350000, PV 350000
PMT 3447 Comp, PMT 3447

The monthly installment based on 180 monthly installments is RM3,447 per month. If the
repayment is by quarterly installment, the amount shall be calculated as follows:
Financial calculator to simplify the computation is as follows:
HP (Input) Display Casio (Input) Display
4, Shift, P/YR 4
15, Shift, N 60 15 x 4 = 60, n 60
8.5, I/YR 8.5 8.5, ÷ 4 = 2.125
2.125, i%
350000, PV 350000 350000, PV 350000
PMT 10376 Comp, PMT 10376

Our purpose of the write up is not the computations of installments per se. Rather it is for
the management of loans. Therefore, let us get back to our topic on how to reduce the
liabilities or to manage these loans effectively for retirement purposes. In order to save
interest expenses, one can adopt several measures:
1. Pay installment at the beginning of the time interval rather than at the end of the
time interval. For monthly installments, time interval between each installment is
one month and the repayment starts at the beginning of each internal. If the
repayment of installment starts at the beginning instead of at the end of each time
interval, interest savings can be significant.
The savings is achieved through shortening of the loan tenure as a consequence of
payment at the beginning of each time interval:
HP (Input) Display Casio (Input) Display
12, Shift, 12
P/YR
BEG BGN
8.5, I/YR 8.5 8.5, Shift, i% 0.708333
350000, PV 350000 350000, PV 350000
3447, PMT 3447 3447, PMT 3447
N 177.47 Comp, n 177.47

The resultant savings = RM3,447 x 2.53 = RM8,724

For the case of quarterly installment, the number of installment that can be shortened is
by paying at the beginning of each time interval is as follows:
HP (Input) Display Casio (Input) Display
4, Shift, P/YR 4
BEG BGN
8.5, I/YR 8.5 8.5, ÷4 = 2.125
2.125, i%
350000, PV 350000 350000, PV 350000
10376, PMT 10376 10376, PMT 10376
N 57.56 Comp, n 57.56
The resultant savings = RM10,376 x 2.44 = RM25,328. We can thus see the impact of a
simple approach of paying at the beginning of each time interval.
2. Another recommendation to manage the loan for cost savings is to pay promptly to
avoid the penalty interest. Penalty interest will increase the interest expenses. This is
applicable before and after the loan has been fully released.

3. Prompt settlement of miscellaneous charges. Miscellaneous charges came about

such as the insurance charges on fire insurance. Although the amount could be
relatively small, the impact can be great. For instance, let us assume the monthly
installment is RM3,447 and the fire insurance charge is RM1,000. When insurance
charge of RM1,000 is debited into the account, the payment of mere RM3,447 will
not constitute full settlement of installment and miscellaneous charges. Penalty
charges will be imposed as a consequence! The awareness on the need to pay these
miscellaneous charges is very low as it is normally not highlighted!
Interest Savings in Partial Prepayment of Housing Loans
One of the hot topics involving housing loans is the interest savings relating to partial
repayment of housing loans. With prior notice and arrangement, some financial
institutions do allow partial prepayment. Such prepayment should enable borrower to
reduce the interest expenses. However, the extent of actual savings may not be so clear to
come individuals. Let us examine the following case study for illustration.
Case Study: Interest Savings in Partial Prepayment of Housing Loan
Donny has a housing loan outstanding of RM250,000 with the Bank of Solo. The loan
outstanding is repayable by another 150 monthly installments of RM2,505.40 each. He
has been approached by an advisor of mortgage loan on how to save interest expense.
Upon execution and implementation, a fee of 10% of the interest savings shall be
charged. Based on a partial prepayment of RM25,000 to be made now, Donny was
informed that he could save interest expense of RM56,167.44. The following shows
how the interest savings is derived:
Based existing loan outstanding and monthly repayment, total amount payable by
Donny worked out to be RM2,505.40 x 150 months = RM375,809.46
After the loan has been reduced to RM225,000 and assuming that the monthly
installment amount remains unchanged, the loan will be fully settled after 127.58
months approximately.
Total amount payable would therefore be 127.58 months x 2,505.40 = RM319,642.02.
Interest savings = RM375,809.46 – RM319,642.02 = RM56,167.44
Donny wanted a second opinion and approached you for advice. How would you advise
him?

Suggested Solution:
In order to enjoy the interest savings, Donny has to make a prepayment of RM25,000.
This amount has to be taken into consideration. Assuming the RM25,000 is surplus
money that earns no return, interest savings shall be as follows:
Interest savings = RM375,809.46 – RM319,642.02 – RM25,000 = RM31,167.44
If the prepayment sum of RM25,000 is withdrawn from another instrument that earns a
return, the savings may not be real. In fact, it is possible that there could be negative
savings. For illustration, if the money is withdrawn from a unit trust account that pay
interest 8% per annum, the benefit forgone in investing RM25,000 for 127.58 months
would have been RM33,357.97. Certainly, Donny will be worse off by making the
prepayment. To conclude, actual savings depend on the opportunity cost of using the
RM25,000. Paying the 10% of so called interest savings or RM5,616.74 is clearly not a
fair deal!
Overdraft
In the legal charge document or facility agreement, overdraft is a type of facility that is
repayable on demand. In other words, a lender has the rights to request a borrower to
repay the loan in full any time it wishes. It can do so any time by servicing a notice
stating that it wants the entire overdraft outstanding to be fully settled. In practice,
however, commercial banks will not pull back the facility as long as the account is
operated satisfactorily. An overdraft account is considered satisfactorily conducted under
some of the general guidelines:
a. It must be operated within the approved limit. In other words, if the account is in
excess of the limits due to interest accumulation, there must be effort seen on the
part of borrower to reduce or settle the interest to ensure that the total outstanding is
within the approved limit.

b. There should not be any dishonored cheque due to insufficient fund. An account
should not be overdrawn without prior arrangement. Otherwise, the number of
dishonored cheques reflects poor financial management and tight liquidity.
 c. The conduct of account must be fairly active, meaning there must be frequent
deposits and withdrawals as a form of income proof. An inactive account is
generally disliked by the lenders.

d. There must be a swing in the balances in the account, thus showing sign of good
cash flows and repayment ability.

As stated earlier, an overdraft account in the Malaysian banking system has been treated
as if source of long term financing because of the practice to allow renewal based on the
guidelines for a satisfactorily conducted account as presented above. Without this mutual
understanding or unwritten rule, a lot of customers would not dare to take up a short term
facility such as overdraft to finance the purchase of fixed assets. On the other hand,
commercial banks are merely asking for trouble if they refuse to renew overdraft granted
to finance acquisition of fixed assets. They would not have indulged in such a practice of
lending short term money to finance fixed asset in the first place!

Computation of Interest
Interest on overdraft is computed based on aggregate of daily balances in a month and
debited into the account on a monthly basis. Let us assume that RM250,000 has just been
released to for the purchase of a shop on 1st September 2008. At interest rate of 8.5% per
annum monthly rest, the interest for the month of September should be as follows:
Aggregate daily balances for September: 30 days x RM250,000 = RM7,500,000
Monthly Interest = RM7,500,000 x 0.085 = RM1,746.58
365 days

At this point, we wish to point out that many clients are confused on the definition of
daily interest and monthly interest. For the case of overdraft, the interest is actually
debited monthly and hence should be considered monthly rest although many have been
told that it is daily rest. On the other hand, daily rest refers to situations where interest is
debited on a daily basis. Taking the same example, we will compute interest on daily rest
basis as follows:
Monthly Interest = RM250,000 x [(1 + 0.085/365)30 – 1] = RM1,752.49
It has become a laughing matter when some lenders advertised to state that their interest
rates are lower because they charged interest on daily basis!
Ignoring whatever mistakes other may have committed, we now want to see how interest
on overdraft can be reduced. Because interest is computed based on daily balances, any
reduction in daily balances will therefore reduce interest expenses. Assuming rental from
the property is RM5,000 per month and this amount is banked into the overdraft on the 1st
day of evert month, this will reduce the aggregate daily balances as follows:
30 days x RM245,000 = RM7,350,000
Monthly Interest = RM7,350,000 x 0.085 = RM1,711.64
365 days
There is thus a reduction in interest expense of RM34.94 for the month due to payment of
rental into account.

Cost Savings in Overdraft Account

We can learn from the above illustration and derive a principle here that whatever amount
that is banked into overdraft account for a duration of even one day will reduce the
aggregate daily balances and hence the interest expense accordingly. That being the case,
customers should be advised not to maintain a current account which pay no interest.
Even when interest is payable on current account, such fund in current account should be
channeled into the overdraft account since the borrowing interest rate is higher!

Caution
One of the advantages of using overdraft is also its disadvantage. Although this statement
sounds self-contradictory. Its validity can be verified. It is indeed a great advantage that
overdraft is usable repeatedly after settlement or reduction in limit based on one-time
payment of legal fees and stamp duty. In other words, after an overdraft has been settled
or close to settlement, the borrower can use it again should any investment opportunity
arise at a later date. The feature of repetition in usage in overdraft is something that does
not exist in the case of fixed loans where upon payment no draw drown shall be further
allowed.

While the advantage of using overdraft should be appreciated on one hand, it could mean
a liability that will not be settled in full after many years, even when borrower reaches
retirement age. This arises simply because there is no repayment programme apart from
the rarely practiced lending term of “repayable on demand” as stated in the letter of offer
or charge document. Very strong financial discipline on the part of borrower is therefore
necessary if he wishes to use this form of liabilities. Otherwise, the loan would seem
never ending!

Conclusion

We have presented the concepts and techniques for computing the effective costs of
major consumption credits and loans incurred for asset financing by consumers in the last
two chapters. There are several implications that can be derived from the findings on
effective costs of consumption credits and loans taken for asset financing in financial
planning:

a. Cut down on consumption wherever possible because consumption or spending

reduces amount available for investment or asset accumulation. There is a need to
differentiate between investment and consumption. Although both investment and
spending involve cash outflow, there will be real or financial assets acquired under
investment. On the other hand, spending does not increase any asset that can
generate future returns in the form of income and/or capital gain.

b. Do not rely on the consumption credit if avoidable. In other words, spent only when
surplus funds are available. Incurrence of interest under consumption credit reduces
disposable income.

c. If it is necessary to draw on consumption credit, do no go for long loan tenure.

d. Compare rates of return of investment proposals with the effective costs of

consumption credit or loans for asset financing. Settle the loans instead of investing
when the proposed rates of return are equal or lower than the effective costs of
funds.
e. Rank the effective costs of consumption credit so that it is clear on the loan to be
settles first whenever surplus funds are available. Remember that settling loans is an
alternative which does not incur investment risk.

f. Be aware that investment in assets may or may not incur borrowings. Any
investment in assets that involve borrowings is always riskier and represent fixed
commitments on regular basis. Interest expenses may be fixed in some types of
loans but variable with the changes in the base lending rates of lending institutions.