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29 March 2024

Borrow and spend wisely to stay financially fit

Banks decide their interest rates for personal loans on the basis of creditworthiness of a borrower, say experts. (EB FILE)

Published
By Sunil Kumar Singh

"Neither a borrower, nor a lender be; for loan oft loses both itself and friend, and borrowing dulls the edge of husbandry" – thus wrote William Shakespeare in Hamlet, a few centuries ago.

But these words hold true for all times.

We all need money to meet our expenses and to invest it to generate more money. But the problem arises when we cross the proverbial Rubicon and often fail to value the thin line between being prudent in spending and profligate in wasting money.

And this is quite a common trend among humans, as behavioural finance would have us believe.

The long and short of it is that money – whether earned or borrowed – needs to be spent wisely.

Not all debts are bad, if you borrow money with due diligence and after carefully assessing your repayment capabilities.

Take the case of personal loans, that is, loans given as credit for personal or family use, as opposed to a loan borrowed to finance a business.

The total amount of personal loans dispensed by banks in the UAE stood at Dh212.3 billion at the end of January this year, according to the latest data from the Central Bank of the UAE.

The amount of personal loans issued at the end of December 2008 was Dh206m.

Generally, in the UAE there are two kinds of personal loans – salary transfer loan and non-salary transfer loan. Salary transfer loans are given to salaried customers and are loans that are backed by the end-of-service benefits by their employers.

Non-salary transfer loans are given to the self-employed category and are more catered to the requirements of the small-sized business community.

So how to get the best from the personal loan without falling into the debt trap?

Assess your requirements

One of the first things an individual needs to consider is whether he or she really needs the loan and what is the purpose he or she is going to borrow it for?

Many individuals often falter on this point as they misjudge their requirement of a personal loan, say analysts.

"The most important factor an individual should know is what does he require the money for – whether it is for an investment, for his child's education or for meeting his expenses," says Vikram Krishna, Head of Retail Loans, Emirates NBD.

"Secondly, he must make sure whether he will be able to repay the loan. He should also be aware of any other loan he is carrying so he is well aware of his debt-burden ratio."

Another factor to consider, Krishna says, is for how long the individual requires the loan and what tenure he is most comfortable with, whether it is two years, three years or five years.

Once an individual fully evaluates why he needs the loan, it's time to turn to the banks and select one that suits his requirements.

But avoid using the scattergun approach when selecting a bank.

Do not start applying for loan with as many banks as you can just for the heck of it, say analysts.

When it comes to choosing a bank, there are many factors an individual should pay heed to.

"The key to finding a bank that you can trust is to do plenty of research. The foremost thing for an individual is to approach a bank that he trusts, gives products and services that benefit the individual and are tailored to the individual's requirement.

A reputable bank will ensure that you have peace of mind and a pleasant banking experience," says Krishna.

He says there are two key factors that one must consider while choosing a bank.

First, one should never be too far away from one's branch. And secondly, choose a bank that has the systems, process and well-trained staff to advise and manage your personal loan.

Assess creditworthiness

Personal loan rates in the UAE are not determined by Eibor rates and different banks have different methods to fix the individual loan rates.

One of the reasons why rates of interest differ from one individual to another is the individual's creditworthiness.

"Rate of interest and the loan structure are determined by various factors, such as what the individual's credit history or the debt-burden ratio is, which employer he is working for, whether he is entitled for the end-of-service benefits and what's his specific requirements are," says Krishna.

Debt-burden ratio is basically the ratio of sum total of all the debt, which an individual is carrying with all the banks and his monthly income.

Krishna says product pricing is dynamic and a periodic activity.

"Just like any other lending product, it is based on cost of money and has to cover the risk associated. "Since the above variables are not fixed and are continuously changing and is different for different individuals, so is our pricing for our products," he says.

Further, there is no minimum salary requirement to be eligible for personal loans in the UAE and different banks fix different salary or income slabs for individuals to be eligible for loans.

Although there have been some cases of loan delinquencies in the UAE, banks have tightened their belts.

The UAE Central Bank has put Dh250,000 as the limit of the personal loan given to an individual.

Further, banks have tightened the screening process to assess the individual's creditworthiness.

"Although there is no collateral or security, but the fact is that if there's any specific employer we're dealing with there's an end-of-service benefit, which means when the employer finalises the settlement with the employee at the time of his leaving the company, it should also take into account if there is any loan that's due to the bank," says Krishna.

However, to minimise loan delinquencies, more needs to be done by banks, say analysts. Mustafa Ramzi, Head of UAE Cards, HSBC, says: "Granting credit facilities is an integral part of banking. Having sound credit policies will minimise risk and ensure healthy banking business. In uncertain times like we are experiencing today, it is all the more important that banks act prudently and equally bank customers plan prudently for their financing needs."

Ways to avoid personal loan defaults

One of the ways to minimise the default risks is to pay in advance one's personal loan installments, say experts.

"If someone advance- pays by two installments, and he loses his job, it will be three months before the bank knows that he is not making payments. So for anybody who has taken personal loan, his objective should be to overpay the loan, which can build a window of safety that will prevent him from loan default.

"Then, even if he loses his job, it will keep him safe for some months until he finds another job," says Steve Gregory, Managing Partner, Holborn Assets, Dubai.

"It is important for banks to assess the affordability of the customer and sanction the loan accordingly.

From the borrowers' side, one of the important things is to be sure why he's taking the money for.

As long as the end use of the money is sensible and it is actually building his capital base going ahead, the borrower should not worry. But if he is using his money for any personal expense, it is a matter of concern.

For the borrower, one of the pre-requisites to understand is whether he is managing the money. He should be clear about why he wants the money, and can he afford to repay the loan amount every month," says Vikram Krishna, Head of Retail Loans, Emirates NBD.

The more sensibly you utilise the money the safer you are. As long as the individual takes into consideration these basic principles, personal loans are terrific products to enhance one's lifestyle and let you achieve your goals, he says.

However, in a situation where a person has outstanding credit card bills as well as he has to pay his personal loan installment in a week or so, which loan should he service first? "It depends which one has the biggest arrears. In other words how many months the person is behind on which one of these two," says Gregory.

"If the person is three months behind his loan and one month behind the credit card payment, he must repay the card loan first, or vice versa.

Under the UAE law, a bank is required after 90 days to report the defaulting loan to the Central Bank. And once that report is made, a person's credit status is destroyed and he runs the risk that the bank will present the security cheque," he says.

Once a person defaults on his loan for more than 90 days, then the bank will make a pro-forma cheque out of the blank piece of paper and present that cheque for full and final settlement. If the security cheque is presented and it bounces, that is when the person becomes a criminal.

Expat vulnerability

The UAE and the Gulf have had a long relationship with the expat population, who flock to this region to live and work.

But analysts believe it is also the expat community that is more vulnerable to loan defaults as, generally, personal loans are unsecured and there is no collateral or any security or guarantor.

"The UAE has a long tradition of migrant, expatriate workers making up a high proportion of the workforce and will always be vulnerable to skips especially during periods of economic adversity.

"In normal times, there is low unemployment and lower likelihood of bad debts but in adverse economic conditions, bad debts increase.

"The skip phenomenon is associated with high numbers of expatriate workers, which is why this phenomenon is not so common in Europe and North America. However, those economies have other challenges, which the UAE does not have," says Mustafa Ramzi, Head of UAE Cards, HSBC.

Janany Vamadeva, Analyst, HC Brokerage, Dubai, says: "For both credit cards and personal loans, it is imperative to evaluate the career history of the applicant as the main issue in the region is that the population is made up of expatriates and hence higher risk profile. Applicants who have lived in the country for a longer time pose relatively lower risk."

But banks are coming to terms with the vulnerability factor and taking steps to minimise risks.

"To determine the [personal loan] eligibility, banks generally see the income of the individual and what's his debt-burden ratio," says Krishna.

Vamadeva says: "At all cost, it is important to focus on the payment capacity of the customer and the previous credit history before issuing a card or approving a loan."