What Is Your True Affordability?

Illustration by Michelle Leong

Over the past decade, lenders and the media had many of us believe that affordability simply means qualifying to make a purchase in cash or through a loan.

Of course, this ended up with some pretty dire consequences. The most alarming is the number of Malaysian households that are now in the red.

Statistics from Bank Negara Malaysia (BNM) revealed that the ratio of household debt-to-gross domestic-product (GDP) in Malaysia has reached 81.9% in 2023, compared to 70% in 2009.

According to BNM, the ringgit figure for that percentage is nearly RM1.4 trillion. The figure puts us at the higher end of the statistic for developing countries in Asia.

Eligibility versus affordability

The problem begins when we confuse eligibility with affordability. This happens when you are considering taking out a home loan or testing your credit card’s limit at the Apple store.

How much can you borrow based on eligibility?

Let us first take a look at eligibility: For example, a fresh graduate earning a starting salary of RM2,500 (an estimated net income of RM2,100). With no existing monthly loan repayments, he is eligible for a home loan amount of up to RM267,991.

Assuming a 4.45% interest rate over a 35-year tenure, he will have to fork out a monthly installment of RM1,260 – that’s over 50% of his monthly gross income!

How much can you afford to borrow?

On the other hand, when we take affordability into context, the amount is a lot less. The golden rule is that your monthly home loan instalment, including principal, interest, real estate taxes and homeowners insurance should not exceed 28% of your gross monthly income.

This is to avoid getting sucked into bad debt or risk foreclosure. If you earn a gross starting salary of RM2,500, your monthly home instalment should not exceed RM700.

What this really means is while the fresh graduate may be eligible for a home loan, he may not be able to actually “afford” it. Besides his home loan repayment, he will also need to factor in other aspects such as property assessment tax (cukai pintu), quit rent, strata title, maintenance and utility bills into his budget.

How inflation affects affordability

Prices have a way of going up from year to year, which means that many of the goods and services we purchase today will cost more next year and the following one.

The increase in prices, also called inflation, results in a decline in the purchasing power of your hard-earned ringgit.  Malaysia’s inflation rate has cooled to 2.0 percent in July 2023. At the same time, the ringgit has been sliding lower, hitting a record low against the US dollar since the 1998 Asian financial crisis.

Generally speaking, growing inflation rates commonly have an inverse relationship with true affordability. The combined impact of rising inflation, mismatched expectations and lack of general financial knowledge had (mis)led many Malaysians into financial mismanagement and ultimately, into the debt trap.

How much are we paying for debt?

The acceptable level of debt-service-ratio is about 30%, meaning that a household should not be spending more than one third of their income on debt repayment.

However, 2023 statistics revealed that the debt-service-ratio of households in Malaysia for newly approved loans stood at 42%. The DSR for outstanding household loans are now at 36%.

This means that Malaysian households use more than one-third of their monthly disposable income on average to service their loans.

According to statistics from the Malaysian Department of Insolvency, some 34,043 cases were categorised bankrupt from 2019 to April 2023. Effective money management is imperative to ensure that one does not fall into the lethal debt trap.

How much should we be spending or saving?

Whether you are a parent with two kids or a fresh college graduate working on your first job, the 50-20-30 money management guideline can help you.

The aim is to figure out how much you can afford to allocate to each expense area every month and the priorities. The guideline basically breaks down all your expenditures into three categories:

1. Fixed costs (< 50% of your monthly net income) – They comprise “fixed” bills and expenses such as rent, car instalments, utility bills, as well as gym memberships and phone bills because you are committed to paying them on a monthly basis.
2. Financial goals (at least 20% of your monthly net income) – These involve putting your money toward your savings long-term contributions such as unit trust funds or Private Retirement Schemes (PRS) to help secure your financial foundation. These funds also contribute to your emergency funds, as well as larger priorities such as securing a down payment for a home.
3. Flexible spending (< 30% of your monthly net income) – They include (variable) day-to-day expenses such as eating out, groceries, shopping, entertainment, hobbies or fuel.

Of course, all guidelines are as they are – just a guide. That said, they can be a helpful benchmark when you are assessing where your money is going.

Understanding affordability and its true implications is important to help you make important money decisions and to adjust your budget according to your lifestyle and long-term goals. Think sustainability when making any financial decisions.

This article was first published in December 2014 and has been updated for freshness, accuracy and comprehensiveness.