By Francisco Colayco
Craving luxury is normal, especially in the consumer-oriented world that we have today. But before you even start thinking about luxury, you must get down to the basics on your financials first.
First and foremost, you should prepare your Statement of Assets and Liabilities (SAL), Personal Income and Expense Statement (PIES), and Personal Financial Plan. In this manner, you know exactly where you are in terms of your financial life, and where you want to be at a certain age.
Thereafter, your most important formula is: Income minus Savings equals Expenses. Then work on a realistic budget after this formula.
Debt is not necessarily bad. If you use debt to buy real needs or to leverage an asset acquisition, debt can really help increase your wealth. In fact, good debt helps to increase your wealth. The key is to be able to pay your debt. One other note, it would be best not to focus on the debt burden aspect of it but rather on the potential cash generation you will embark on to clean up your debt. This is a technique to develop a positive mind set. And a positive mind set tends to attract positive things to happen. More often than not, with a positive mindset, your mind gets focused on opportunities rather than problems.
Credit card is another matter. One serious concern is the desire of some for their credit card limit to increase, even when their salary remains the same. Again, back to basics.
Credit card limits are set up to 1) make sure that you have the capacity to pay for your usage, and 2) protect you in case someone else gets a hold of your credit card.
You can only use it up to your limit, so why will you want to increase your limit if your capacity to pay has not changed? Of course, if your original limit was so much lower than your capacity to pay, then by all means, request for the increase. Usually, the credit card company will increase your line if you always pay on time. They might also ask for your Income Tax Return (ITR) to prove your capacity to pay.
Regarding your income issue, if your salary is not increasing, credit card usage is not the answer. You need to increase your income and/or to cut your expenses some more. But, in either case, remember to ‘pay yourself first.’
What To Guard Yourself Against
From our informal surveys, the single biggest factor that causes the most financial problems is premature acquisition of long-term assets.
Most people dream of owning their home; this is top priority and is almost always grabbed as soon as there is enough money set aside for a downpayment. Not enough attention and study is made whether or not the incurred liability of a monthly amortization can be matched with an assured income stream over the same period of debt payments. The common comment is always ‘gagawan ng paraan,’ or ‘We will cross the bridge when we get there and find a solution.’ And what is the solution found when the income cash flow is insufficient to cover debt repayment? More borrowings!
This is not so bad if it were only a temporary shortfall. The sad part is, because there is a mismatch from the very beginning, the borrowing incurred is short term and more expensive, and thus further pulls the household into a downward financial spiral. Hope and aspiration, both positive by nature, turn into a heavy burden. Inability to keep up with payments leads to foreclosure. The downpayment and amortization payments already made would have been an excellent source for wealth generation. With foreclosure, all that and more is lost. Debt after debt after debt is a surefire formula for bankruptcy.
The fundamental principle that should never be violated when it comes to incurring debt is quite simple. The source of repayment to cover the incurred obligation of debt payment must be determined and secured before any debt is incurred. Have long-term income to cover long-term debt. Use only short-term income to cover short-term debt. There is no room for mismatching. Certainty of the source of repayment must be established before the debt is incurred.
The nature and character of debt must be fully appreciated. Money received from debt is not our money. It belongs to someone else and must therefore be repaid. The interest we pay is for the privilege of using someone else’s money. This is the cost of borrowing. The principal of the loan is what we really owe. Likewise, it must be returned on due date. Unfortunately, this basic truth somehow gets lost in the manner that debt is incurred.
In credit card debt, most who have fallen victims and found themselves in deep trouble usually did so because in their minds, the credit limit was cash they already own and could be spent as they pleased.
The Blessings of Debt
Successful entrepreneurs pride themselves of achieving their successes using “other people’s money (OPM)”.
Traders employ this tool everyday of their commercial lives. They buy on credit and sell for cash. Or, they buy on long-term credit and sell for a shorter credit term. In either case, they use their suppliers’ money (OPM).
This is just one example of proper use of credit. The point here is that they are able to borrow and use the borrowed money to produce returns higher than their cost of borrowing. They were able to do so because they have established a credible track record of debt repayments.
Credit worthiness can bring countless blessings to those who deserve it. Other entrepreneurs start up their business using only their intellectual capital and use OPM for both permanent and working capital requirements of their businesses.
Again, in this case, their success lies in their credibility as reliable business performers. The principle is simple: financial support comes only to those who are financially responsible. This does not always mean being able to pay on time. But it always means being able to face your creditors in both good and bad times, and in the case of the latter, being able to propose solutions when debt problems arise.
My new book, “Wealth Reached. Money Worked. Pera Mo, Pinalago Mo!” is now available on www.colaycofinancialeducation.com and National Bookstores.
Debt is not necessarily bad. If you use debt to buy real needs or to leverage an asset acquisition, debt can really help increase your wealth.
Have long-term income to cover long-term debt. Use only short-term income to cover short-term debt. There is no room for mismatching.
Contrary to popular belief, debt is not the financial monster that most people paint it to be. In reality, debt can be your friend—only if you know how to sweet talk to it and get it to play on your side.