United Arab Emirates: How to Set Up a Repayment Plan When You Borrow Money
Dubai: It is essential to calculate the total cost of credit you take out, including interest, and not just how much you borrow or how much you can afford to pay each month.
Taking the time to calculate the total cost of any borrowing helps you plan your finances and make sure you can really afford it. However, let’s start by understanding what affects your borrowing costs.
Know which plan affects your borrowing costs the most
The amount you will need to pay to borrow money depends on how much you need and how quickly you plan to pay it back.
For example, if you want to borrow a small amount for a short period of time with a low interest rate, you could very well pay very little interest (or even none if you are using a 0% interest credit card).
On the other hand, borrowing a large sum of money over a long period will cost you more.
It is generally recommended to use the APR (the annual percentage rate or the interest rate for an entire year), rather than a simple subscription or monthly rate, to compare products. The lower the APR, the better, but also look at how much it will cost overall.
This will usually be more for a longer term loan, even if the APR is lower, and will appear as the total amount payable.
What are my borrowing options?
Let’s look at an example. Suppose Khalid needs to borrow 1000 Dh to replace his old water heater.
He gets a quote from an energy company for the water heater and installation, including reimbursement of the cost over two years.
However, when Khalid reads the contract, he realizes that if he withdraws their credit for two years, he will pay more than 300 Dh in interest.
Khalid is looking at other options. As Khalid has a good credit rating, he also considers the following:
â¢ Take out a credit card with a 15-month interest-free introductory period on new purchases, or,
â¢ Apply for a personal loan with an interest rate of 10% that it can repay over two years.
Here’s how much Khalid might have to repay each month and overall:
In the end, Khalid takes a look at his monthly budget and decides that he can afford to take out the credit card and pay the extra 10.76 Dh each month to avoid having to pay interest.
This means that he will have paid the balance in 15 months and he will not have been charged interest. Khalid will only save money because he knows he can make the payments within 15 months.
If you don’t think you can do it, a credit card could cost you more.
This chart shows the difference between repayment plans over different time periods and how being able to pay a little more each month can mean you can take out a much cheaper form of credit.
It also emphasizes the importance of shopping for credit and not just taking the first product that is offered to you.
To note: Always spend time looking for credit. Use comparison websites to check out different offers. Be aware of any additional fees or charges. All loans should tell you how much you will repay overall, including interest.
Regular or flexible payments
A loan agreement will have an amount that you will have to repay each month. It may charge a prepayment fee if you clear it in advance.
While some banks don’t charge an early settlement fee on personal loans, others charge one percent – the maximum penalty allowed by UAE central bank guidelines. This means that if you have an outstanding balance of 100,000 Dh, you will pay 1000 Dh to prepay the loan.
Is it profitable to prepay your loans?
While paying off debt before it’s due is a great way to increase your monthly income, it’s not always the easiest process.
If you have a credit card, for example, you can erase it without any repercussions. However, if you pay off a personal loan early, you risk a penalty, like the 1% fine discussed above.
The same goes for auto loans. Clear the balance sooner and you’ll invariably be stung with a 1% early settlement fee.
Is it time to shop around for a new loan?
One thing to consider for personal loans is that if you took out your loan some time ago, the market may have changed and rates may have come down.
So if you don’t have the money to pay off the balance now, it may be worth looking for a new personal loan and finding an offer that will lower your payments.
After knowing the interest rate you are currently paying, also determine how much you will pay back if you stay with this deal and how much you will pay if you write off the debt now. Also ask what the penalties are if you pay them back now.
After which, add the cost of repaying the loan now to the penalty total and use that figure to compare your loan with other personal finance options on the market.
If the other options can’t beat the number, stay where you are. However, if the total cost of the new loan is less than the figure, move on to a new deal.
However, you have to walk carefully. For starters, you can incur this 1% early settlement fee. You may then have to pay an upfront fee or arrangement fee on a new loan, which is also usually one percent of the loan.
Also, when evaluating a new loan, you should determine whether it is a fixed or declining rate, as the comparison of the two will be misleading.
Paying off your loan early at any time, in whole or in part, can be a good way to keep costs down. You can ask the lender for a âpayment statementâ showing how much you will save by prepaying.
Other forms of borrowing such as overdrafts and credit cards are more flexible with little or no minimum repayment. But the interest rates on these tend to be higher, and some overdrafts charge an initial set-up fee.
Some key benefits of regular repayments: Paying off a regular fixed amount can help you budget because you know exactly when you’ve written off the debt.
You should be able to prepay your loan without penalty. However, on the other hand, regular payments can also be a downside and can make budgeting more difficult if your income fluctuates.
Calculating the cost of borrowing
You can calculate how much it will cost you to borrow if you take out a loan or a credit card by using the information that lenders have to give you.
When you apply for a debt transaction, they tell you how much you will need to repay in total, how much you will need to pay each month, interest rates, fees or charges, and the APR.
You should find this information on the credit card or on the loan company‘s website. If it’s not on the website, the company will need to send it to you before making the deal and explain the key elements of the deal.
In the case of credit cards, this will be based on certain assumptions about how you will use the card. You can also use an online calculator to calculate the true cost of any borrowing – and it will only take a few minutes.
To note: Any deviation from your repayment schedule and you could be affected by additional fees and charges. It could also hurt your credit rating, as lenders look at how you’ve handled your existing credit when determining whether or not to lend you money.
Make sure there is enough money in your bank account each month to cover your refunds and set up a standing order (for a fixed amount) or direct debit (if payments vary) so you don’t miss any payment.