As the popular saying goes, ‘desperate times call for desperate measures,’ and with this pandemic, considered as one, many people turn to get loans to stay afloat.
However, as most people know, this is a game that doesn’t always end well for everyone. So if you plan to take out a loan soon (which is totally understandable), here are some tips that you should keep in mind to avoid falling into a spiral of debts in the UAE.
5 Things You Should Do to Avoid Falling into Debt During the Pandemic
In the UAE, figures show that 47% of the population — or 4.3 million citizens — are in debt, with 13% actively seeking a loan.
Here are several pointers that financial advisors suggest their clients to bear in mind when attempting to escape excessive debt in the UAE.
Tip 1: Limit your DBR.
Lenders assess prospective borrowers’ repayment capacity by taking into account their existing Debt-Burden Ratio (DBR). Your DBR is the amount of debt that is deducted from your monthly salary.
A DBR of close to or greater than 50% will disqualify you from further borrowing. The legal limit in the UAE is 50%, so if you were paid AED 10,000, make sure your repayments do not exceed AED 5,000.
Financial planners suggest that your DBR be in the 25-30% range to allow for periods when you may need additional credit.
Tip 2: Look at debt consolidation options.
If you can get a new loan with better terms and a lower interest rate than your current debt, consolidating it with a personal loan can be a good idea.
It entails taking out a low-interest loan to pay off higher-interest loans. Qualification is based on your credit ratings from the Al Etihad Credit Bureau, as well as your salary and other financial factors.
You can consolidate all of your current loans and credit card debt into a single loan to benefit from lower interest rates, longer repayment terms, and lower monthly payments.
Tip 3: Maintain a low credit utilization rate.
You can do this by tracking spending, adjusting payment schedules, or requesting higher credit limits. The trick is to only use a portion of your credit.
Your credit utilization is simply the percentage of your available credit that you use. It is the sum of all your credit card balances divided by the sum of all your credit limits.
However, if you do rely on credit cards during a financial crisis, such as the one we are currently experiencing, planners advise you to bear in mind that credit scores will easily recover until you are able to reduce your utilization.
Tip 4: Do not use your credit card for cash advances.
It is generally recommended that credit cards not be used to obtain cash on hand. Not only is the APR higher than on typical transactions, but you’ll also be paying a large fee, and your debt will grow.
(Annual percentage rate (APR) is the annual rate of interest charged to creditors and paid to investors.)
Tip 5: Try the ‘debt snowball’ strategy.
If you can afford to pay more than the minimum monthly payment on your credit cards, try using the debt snowball method to expedite the process and gain momentum.
As a first step, make a list of all the debts you owe, from smallest to biggest. Spend all of your extra money on the smallest balance, while making the minimum payments on all of your larger loans.
If you’ve paid off the smallest balance, start putting extra money into the next smallest debt before you’ve paid it off, and so on.
Paying off your small balances will free up funds for larger loans.
Because of the “snowball effect,” you will pay down smaller balances first, leaving the biggest loans for last. The aim is to apply all extra dirhams to your debts before you’re debt-free.
These are just some of the things that you can do to limit your spending capacity, and in effect, minimize the amount of debt you incur with each spend. Remember, simply because the world is facing a crisis doesn’t mean that your finances should too.