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Borrowers beware
One of the most important financial decisions you will make in the UAE, and the easiest to get wrong, is what personal loan to take.
The price for picking the wrong one is high and if you don't pay close attention to the conditions attached to your loan agreement, you could find yourself carrying a heavy financial burden.
That almost happened to James Wilmot, a 25 year-old accountant from Dubai who discovered on studying his loan agreement that the interest rate he had originally been quoted by the bank's sales person was in reality, far higher.
"I originally chose a loan from the bank I had opened an account with but I discovered that the salesman had lied about the rate of the loan, and as a result I decided not to borrow money from them and in fact ended my relationship with them entirely," he says.
"I went looking elsewhere and now have a loan with another local bank which I am very happy with."
Wilmot's experience proves the importance of reading the small print behind any loan agreement.
It is here that you will find, buried away, the information that distinguishes one loan from another - the terms and conditions, interest rates, processing fees and other charges such as deferment and early repayment penalties.
And armed with this knowledge you will make a choice that enables you to live the lifestyle you want and does not leave you overburdened with debt.
In the UAE the maximum amount of money that a bank can loan out to an individual is set at US$68,000 (AED250,000) and the terms over which this must be paid back vary from 12 months to around 72 months.
The most important question to ask any bank when signing up for a personal loan is how much will you actually pay back every month in installments - and how much you will have paid back in interest by the end of the term of the agreement.
One of the most confusing details regarding personal loans is interest rates which vary greatly between different banks - both in terms of the rates offered and the ways in which these rates are calculated.
For a start borrowers have the option of choosing a personal loan with an interest rate that is fixed or variable. A fixed interest rate will not change for the term of the loan - however one that is variable will fluctuate according to the strength of the US dollar to which the UAE's currency is tied.
Daffer Luqman, Head of Branch Management for HSBC Middle East, explains the advantages and disadvantages of both: "Some clients would rather know that whatever happens to the interest rates market, they are not going to be affected. Normally customers go for fixed payment facilities in times of low interest rates because they want to lock up the attractive rates for the period of the loan. Others take a different view of the market and changes in interest rates and they prefer the variable option so that they can capitalise on times when the interest has dropped."
"The interest rates here are linked to the US dollar and we've seen quite a bit of stability in the last 18 months or so," he goes on to say.
A practice by some banks in the UAE marketplace is to quote interest as a flat rate as opposed to interest on a declining or reducing balance rate basis.
Flat rate interest will usually be a lower figure than a declining or reducing balance rate - however it is not a true reflection of the interest you will pay as it does not take account of reductions in the loan balance which occur as repayments are made.
For instance if a person took out a loan of US$40,000 over four years with a flat interest rate of 5% the interest charge for the first year would be US$2000. This would remain the same despite the amount outstanding on the loan reducing.
So in the fourth year once the outstanding balance has reduced to US$10,000 the customer would still have to pay US$2000 - which is in effective an interest rate of 20%.
A reducing balance rate however is calculated on the basis of the amount the customer has to pay - so even if this is quoted at 7.5% it would still be cheaper than a flat rate of 5%.
So it is very important to calculate the full amount of interest you will have paid by the end of the term of the loan as well as what you will pay each month - and not to be fooled by deceptively low flat rates.
"Sometimes in this market interest rates will be quoted as a flat rate and then there's declining balance rates," warns Owen Belman, Standard Chartered Bank's head of consumer banking for the UAE and Oman.
"The flat rate will always appear as a lower number than the actual interest rate a customer ends up paying."
"Here the market practice is to quote the flat rate, not the reducing rate," adds Nabeel Malik, chief marketing officer of Mashreqbank. "This makes it sound as if the loan is a lot cheaper."
Some banks will also advertise attractive introductory "teaser" interest rates that will rise to a higher level after a certain period.
Borrowers must be clear that these are indeed just introductory rates and should find out exactly when the rate will return to the bank's usual higher level.
"If there were for example an initial rate then a go-to rate that is substantially higher, then this should be communicated immediately upfront," says Belman. "I think it's completely appropriate to have an introductory rate followed by a second rate which can help to attract new customers. But it must be made clear that the actual rate will be much higher a few months down the road."
Interest will not be the only addition to your monthly loan repayments.
The true amount you will pay back could also include processing and arrangement fees and charges - the details of which are sometimes hidden deep in the loan's small print.
Processing fees are usually calculated as a percentage of the full loan amount and can, if customers do not read the small print, appear as an unexpected add-on to the first month's installments or spread out throughout the term of the loan.
"What you should be very mindful of is hidden costs such as arrangement fees, because sometimes these are not mentioned to you until you actually draw the loan out," says William Borland, senior relationship manager at Barclays Wealth.
"And suddenly you see your first month's installment and it's a lot more than you expected it to be. I've seen banks charging as high as US$2000 for processing fees," he warns.
Most banks charge around 1% of the loan amount for processing fees and this can either be paid upfront or spread out over the term of the loan.
Craig Holding, financial advisor at Acuma Wealth Management in Dubai, strongly advises customers to insist on paying any processing fees upfront and warns that otherwise the fees could acquire interest.
"One of the pieces of advice I give to anyone who is considering taking out a loan is make sure the bank doesn't add those fees to the loan because you'll end up paying interest on them. It's far better to pay the fees upfront. People think it's a great idea for the bank to attach the fees to the loan - but it will cost the borrower more in the end."
For expatriates who cannot necessarily predict how long they will need or want to remain in the UAE, another major detail to enquire about before taking out a personal loan is early repayment penalties.
Banks will not thank you for paying your loan back early because it means they are losing out on future earnings through interest and that is why they charge often costly penalty fees for doing so.
These fees can vary from 1.5% to around 5% and depend on whether the customer is paying the loan back from their own resources or if the money is being transferred from another bank - in which case the fee is always higher.
"Early repayment fees are a very important detail," says Holding. "You need to know what will happen if you need to leave the country for good and you've still got a five-year loan to pay off. How high will the fees and charges associated with that be?"
Banks will also charge penalties for late payment or deferment of a monthly installment and customers should check how high the penalties would be and how the interest is calculated on such a deferment.
"If the customer with an installment loan decided to defer a payment say if they went on holiday or they had a temporary financial problem, then there would be a fee for doing that," said Belman.
"You also have to look at how the interest is handled on a deferment and whether it is deferred for one installment or whether it would be deferred until the end of the loan which would have a compound effect," he goes on to say.
For those who fail to read the small print that goes with a personal loan and only discover part way through the repayment period that the costs are far higher than expected, there is one possible way out.
Many banks offer balance transfer programmes in which they will buy out their rivals' loans from customers, offering them the chance to repay the remaining balance back at a lower rate of interest or with more manageable monthly installments.
Financial experts recommend this as a good solution for those caught short by an expensive personal loan deal. Luqman of HSBC says: "It's a good thing if the buyout opportunity is used to better structure the debt of the borrower, so that they can start out afresh and repay their debt comfortably with a lower rate of interest on the cost of borrowing."
Borland adds: "There could be a very good reason for changing your loan to another bank's such as reduced interest rates."
However, he warns borrowers considering such a move to investigate thoroughly the conditions offered by the other bank - and to watch out for any penalties they may be charged for transferring the loan from their existing provider.
Most banks will charge a fee for a balance transfer - rising to as high as 5% of the outstanding balance. "If the client cannot afford the existing payments then it may be a necessary evil. But what you have to look out for is the exit penalties from the previous loan and the new charges affecting the new one," says Borland.
A balance transfer is certainly something to consider if you are struggling to meet your loan repayments - as banks will come down hard on anyone who fails to repay their loan.
Unlike in countries such as the UK, if a person goes bankrupt in the UAE they will often end up facing criminal proceedings and there are few organisations to turn to for help if your debt spirals out of control. "There are no companies dealing with these issues in the UAE and it's a case of either you pay or you go to jail. Once you are caught up in debt it is a vicious circle and the consequences are grim because you have no alternatives and no organisations to go to for help," says Sandi Saksena, senior consultant at Nexus Insurance Brokers in Dubai.
Until fairly recently there has been no credit-checking bureau in place in the country although Emcredit has now established itself as the first independent credit bureau in the UAE. The situation has meant that banks have had no way of finding out a person's financial history or how many other loans and credit cards they already hold before lending them money.
This can make it very tempting for consumers to borrow more money in order to pay off existing loan and credit card debts.
"There is an infrastructure that is in a lot of the more developed markets that allows people to take decisions easier based on someone's credit history," says Malik. "Right now we can only rely on people's honesty to tell us what their credit history is and to show us their bank account statements. But if a person has five bank accounts and they only give us statements for one of them there's no way for us to find out about the others. And when people have a strong financial need they will tend not to tell all the truth."
Banks will take legal action against those who do not repay their debts - including those who leave the country for good without paying off a loan.
For non-repayment of a loan they will pursue the borrower through the Civil Courts.
Ali Amiri of Dubai-based law firm The Attorneys, explains that the Civil Court can issue a judgment saying the borrower is obliged to make the payment. Then the bank will execute that civil judgment and will obtain an arrest warrant against the borrower for non-payment if he does not pay within two weeks. "The court then asks the borrower if he can pay within seven days. If he does not do that or if he fails to come up with a schedule for payment then he will go to jail and he will remain there until he pays," he explains.
Banks claim however, that this is a last resort and that before taking legal action they prefer to discuss the situation with their customers and find an easier way for them to pay the loan back.
Malik, says: "There is a whole process we follow. First we call the customer reminding him or her that his payment has not been credited into his account and we remind them to do that. That is followed by another call reminding him that his previous installment is due and his next installment is also coming up. If that does not work then we look at debt counseling and we look at rescheduling the debt to make it easier for him. If all those efforts fail then we are forced to take legal recourse."
Luqman of HSBC adds: "We have a team designated to work with these borrowers and we help them to overcome the situation by looking at their personal circumstances. If needs be we would reschedule the facility for them.
"In the ultimate case where the borrower is unable to repay the loan amount the case is forwarded to the legal department."
To avoid getting into such dire circumstances financial experts recommend borrowers to consider various steps before taking out a loan. They strongly advise customers against taking out new loans to pay off existing ones as this will only compound any existing debt problem, recommending clients to find a solution by discussing the situation with the bank.
"The best thing to do is to go back to the bank and negotiate and say ‘I'm having a problem', but instead of doing this many people will just go and get another loan to pay off that one. And before they know it they're completely overburdened with debt," says Saksena.
Holding advises clients to keep an emergency supply of money in an offshore bank account or an account based in their home country in order to repay the loan in case they face unexpected financial difficulties or have to leave the country.
This is particularly prudent as banks will often freeze the assets of anyone who loses their job in the UAE until they have paid off the loan in full - or have started another job and are able to continue making payments.
Experts agree that taking out insurance on the amount of the loan is also very important as it protects the borrower in the event that something happens to them and they are unable to pay off the debt. It also ensures that the family of the borrower will not be burdened with the debt in the event of the borrower's death.
Some banks, such as HSBC include this insurance automatically and add the charge for this to
the cost of the loan, whereas others will offer it as an option.
"One of the questions we advise customers to ask banks is whether they offer insurance in case anything happens to them," says Luqman.
"In HSBC we insure the customer to the amount of his borrowing so that if anything happens to them their next of kin does not need to worry about paying off the facility. This is built into the cost of the loan and we make it mandatory for all customers."
As an extra precaution Holding believes all borrowers should also have income protection in place:
"What happens if you lose your income through sickness or injury? You need some sort of fallback plan in place to protect you and your family. This is particularly important if you have any form of debt."
With these safety nets in place, customers can be reassured of some protection should they fall on hard times. However, there is little to protect customers who simply pick the wrong personal loan and end up paying back a far higher price than expected.
So tempting as the offers might be - it is vital to look before you leap when choosing a personal loan and most importantly not to ignore the small print.
The UAE's thriving loans industry relies on the fact that every year thousands of expatriates will arrive in the country to start a new life from scratch and in the majority of cases will need a loan to get themselves started.
But while loans can provide a life raft to borrowers in times of need those who don't take the right precautions before signing up could find themselves drowning in debt.
Why did you decide to take out a personal loan?
I used the loan to transfer existing debts from the UK - I worked out it would be cheaper to service a loan from the UAE, rather than transfer money back to the UK on a regular basis.
What personal loan did you take out?
I took out a personal loan with Emirates Bank for around US$54,400 - I later increased it to pay the rent on an apartment, but have since paid back that extra amount.
Why did you select this particular loan and what factors did you look out for during the selection process?
When I went looking for a loan the most important factor to me - aside from a decent rate - was transparency of charges and clauses, and the attitude of the salespeople and staff. Because I would be arranging a salary transfer loan, this also applied to the current account.
I chose Emirates Bank because they seemed to have as good a rate as any other bank, if not better than most (9.5% compared to the 17% a rival bank offered). They also offered the facility to change the monthly payment amount for a reasonable fee, which would allow me to increase the amount I paid as my circumstances changed.
My questions mainly related to the charges I'd incur if I made changes to the loan, like extending it, early repayment, etc.
Did you ask the bank to quote the full amount you would be paying off by the end of the loan?
Yes, I was given a full schedule for the lifetime of the loan, which I would have requested otherwise.
Did you find the process easy?
The process was relatively easy, although required more paperwork than I was used to.
I also had to reconcile my ‘evolved' signature from the earlier version in my passport, which delayed the loan by a week.
Are you concerned at all about your ability to pay back the loan?
No - I had been making payments on a similar amount in the UK. At the time I took out the loan, I was gambling to a degree on future salary increases - if these had not happened, I might have struggled in the longer term.
The main principle of Islamic finance and banking products is that all forms of interest are forbidden. The Islamic financial model works on the basis of risk sharing. The customer and the bank share the risk of any investment on agreed terms, and divide any profits or losses between them.
Some of the principal Islamic banking products are:
• Murabaha - A form of credit that enables customers to make purchases without taking an interest-bearing loan. The bank buys the goods for the customer and resells them to the customer on a deferred basis, adding an agreed profit margin. The customer then pays the sale price for the goods over installments, effectively obtaining credit without paying interest.
• Ijara - A leasing agreement in which the bank buys and then leases an asset (for example a car or a property) to its customer for a specified rental over a specified period of time. The bank may have the right to adjust the rental charge in line with changes in the cost of finance. This method can be used for home buying purposes ("Islamic mortgages"). This usually entails the customer making capital payments in addition to the rental charge. The customer's ownership in the property increases and the bank's decreases by a similar amount with each such payment. Once all payments have been made, ownership of the property passes to the customer.
• Commodity murabaha - Islamic banks use this product to replace conventional inter-bank deposits. It involves the sale and subsequent re-purchase of a commodity (normally a base metal which is traded on a major exchange). It is structured in such a way that it is essentially similar to a loan granted by the seller to the buyer. The difference in the sale and re-purchase price earns the seller a return equivalent to interest.
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